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Disclaimer: Nothing on this page should be construed as legal, financial or tax advice. Please always consult a knowledgeable professional advisor.
When you calculate the value of a business, you gain a better idea of your commercial successes. Assets are everywhere in life – your car, your home, and your small business all have a price.
Whether you’re planning a small business valuation and have plans to sell your venture, you’re planning ahead, or merely curious, it’s good to know where you stand. This article sets out the key small business valuation concepts every independent company owner should know.
Why should you value your business?
Selling your company isn’t the only reason to pursue a small business valuation. Running the numbers can also help you to understand your company’s financial health, which can play into all aspects of management.
You might work on your online store to increase profits or use loyalty software to keep customers engaged through a period of change.
A small business valuation can help:
- Secure funding for your business by giving investors a realistic idea of what your business is worth.
- Point you towards areas of focus by sorting the financially healthy aspects of your business from those that may be struggling.
- Set a price for shares in your business – whether shareholders wish to buy or sell.
- Inform plans, whether these are for your retirement, next venture, or for an exciting expansion.
How do you calculate business value?
There’s no set way to approach a small business valuation. That said, there are a few concepts to be aware of when you start to calculate your business’ value:
Price-to-earnings ratio
The P/E ratio, or price-to-earnings ratio, allows you to measure your small business’ current share price relative to its earnings per share (EPS). It’s a tool that allows you to value stocks based on their past or projected earnings – you can then use this figure to calculate business value.
To calculate price-to-earnings ratio, you need to first know the earnings per share (EPS) figure. This is the amount of profit attached to each share of a firm’s common stock. Take this from your small business’ most recent year’s financial results – the trailing 12 months (TTM) – or use forecasts to estimate your company’s EPS going forward.
The main disadvantage of this measure is failure to accommodate earnings growth. If your EPS is growing fast, this won’t be reflected and your business could be undervalued. However, this measure is widely used in business valuation and it’s a useful way to show what the market would pay today for each stock.
Asset valuation
Asset valuation is another useful small business valuation measure – though stocks and earnings are important, the assets your company owns also shape its value. It uses measures such as book values, comparables, and various pricing models to work out the current market value of assets.
To calculate a net asset value, you will need to add together the value of all assets in your portfolio, including cash, and both tangible and intangible assets. Then, take away liabilities such as debts on a business mortgage. Finally, divide this by the number of shares.
Entry cost
This type of valuation works by referencing the cost of building a similar business from scratch. It can add context to small business valuations by grounding them in real-world replacement costs.
To calculate entry cost, make a list of start-up costs, tangible assets, staff needs, and product development efforts. Then, place an estimated figure next to each.
Discounted cash flow
The discounted cash flow business valuation method is an income-based approach, so it’s best suited to established firms with stable cash flow.
Apply an interest rate to cover risks and inflation and add projected takings for the coming years, plus a residual value. The latter is an estimated value of the asset at the end of the period.
Industry practices and rules of thumb
Industry practices can give your small business valuation rooting in the real world. It’s especially useful in sectors where businesses are regularly bought and sold, and where industry-specific factors influence value.
For instance, if you run a chain of bars, the number of outlets in the chain will likely influence business value. To implement this technique, it’s a good idea to research recent business sales in your sector.
Analysis of comparable businesses
Comparable analysis goes one step further, allowing small business owners to pit their business against similar firms that have recently been sold. These might be within your industry, or outside of it. These competitors might employ a similar number of staff or hold a like-for-like asset profile.
To use comparable analysis in your small business valuation, source relevant business sales whose estimations are in the public domain.
What affects business value?
Several intangible factors can affect business value as well as the tangible assets you’ve used in your calculations.
These might include:
Reputation and customer value – if your business has a strong reputation and established customer base, it’ll likely be worth more to potential buyers. When these things are pinned to a recognisable brand, the impact on small business value might be greater still. Dedicated customers are strongly related to future revenue.
Your team – a small business derives part of its value through its people. The number of staff your business employs will give potential buyers an idea of scale, and the quality of the talent could have an impact too. In some sectors, rival firms may seek out competitors to harvest this talent.
The circumstances leading to your valuation – if you’re seeking to capitalise, your business will likely be in a strong position. If your services receive a boost in attention or demand, then this effect may be more pronounced. A forced sale will usually draw a lower sum than a voluntary sale.
The age of your business – they say age is just a number, and, in many ways, they’re right. Your bottom line is far more important. A company’s age provides important context, however, a decades-old firm might appear reliable. Whereas, a shiny tech start-up could appeal to buyers with a thirst for potential.
The market your business is in – some industries are simply more lucrative than others, and this picture constantly changes. In a lucrative market, a small business with all the same valuation figures could be assessed more favourably.
The state of the economy – whether the economy is in recession or upswing makes a difference.
Your financial record – bad credit can impact a small business valuation.
Trademarks and intellectual property – owning high-value intellectual assets could swing a valuation in your favour.
How to get a good small business valuation
Whether you’re chasing a sale or an accurate benchmark, it helps to set some things in place so you can get the most from your small business valuation.
You might work to:
Minimise risk – since revenue reduction can have a big impact on business value, think about how to strengthen your relationships with clients and minimise the risk of relationship breakdown.
Organise – poor recordkeeping could impede an accurate business valuation. So, take some time to gather at least three years’ profit and loss statements, tax records, purchase receipts, credit reports, and any licences or deeds.
Improve your profitability – when profits are on an upward trajectory, it can be easier to negotiate. Making savings or changing the way you work could impact the numbers.
Make a business plan – a small business valuation is all about looking towards the future, so having a solid plan can set you on a good course. This adds context to your calculations and reassures potential buyers.
Seek professional advice – speaking to people who understand the process may help. They might advise on the best small business valuation method for your company or help you to run the sums. Some accountants also specialise in calculating company values.
Be prepared to negotiate – after you calculate a business’ value, the art of negotiation can prove important. While you should avoid overestimating the worth of your business, there’s no harm in arguing a case for the importance of your intangible assets. Your people, premises and even relationships with suppliers can all run in your favour.
Growing your business value through tools and software
Is there room for improvement within your business? Deploying smart strategies now could reap rewards later.
Square can help with many aspects of business finances, from payment hardware you may need to process payments to wider marketing tools. Getting your business on a path to growth and nurturing your customer base through loyalty software can help to give the right impression at the right time.
