No matter if you are looking for investors, taking a loan, or selling your small business, you’ll have to evaluate the company’s worth. Read this post to know three of the most popular valuation methods used for small businesses.
Business valuation is the process of evaluating the economic worth of a business. If you want to sell your small business, the evaluation can help you know a fair selling price. If you are looking to purchase a small business, it can help you decide whether or not you are paying a reasonable price.
Apart from buying and selling, business valuation is also crucial if you are looking for investors, applying for a loan, buying out another business, merging, or offering equity to your employees.
While there are several valuation methods, three of them are very commonly used for valuing small businesses. Take a look-
1.Market Value Valuation
The market value valuation method is most commonly used for valuing small businesses. It determines a company’s worth by comparing it to other similar small businesses. As the process considers the value of similar companies that have already been sold, it cannot be used when sufficient valuation data of competitors is not available in the local market.
Also, as the valuation is abundantly dependent on the sale data of other similar businesses, the market valuation method is considered to be imprecise. Negotiation thus, becomes very crucial in case you want to sell or are looking for investors for a business, using this method.
The DCF or Discounted Cash Flow valuation method, also known as the income valuation approach, relies on the projected cash flow and the time value of money for determining the current value of your business. It is commonly believed that the value of money falls with time. For instance, if you have $1,000 today, you can invest it and turn it into $1,200 five years from now.
The DCF method lays a major emphasis on the falling value of money with time. As a result, it is also abundantly used for comparing investment opportunities. With regard to business valuation, this method is very commonly used for small businesses whose profits can be expected to increase considerably or fall in the future.
As the name suggests, this method evaluates a company’s worth based on the total net asset value of the business after deducting the total liabilities as per the balance sheet. Two different approaches are used within this asset-based valuation method- going concern approach and liquidation approach.
The going concern method is used in case if the business is not being liquidated. It considers total equity (assets minus liabilities) for business valuation. The liquidation approach takes into account the liquidation value or the net cash of the business, assuming if it sells all the assets and pays off all the liabilities.
Selecting the Right Business Valuation Method for Your Small Business
Several factors are taken into consideration while selecting a valuation approach. Apart from the three commonly used business valuation methods discussed in this post, there are others like ROI-based, capitalization of earnings, multiples of earnings, etc. that can be used for evaluating your small business. Moreover, even a combination of these methods can be used in some cases.
As a business owner, the best way to select the right valuation method for your small business is to look for a reliable valuation advisory service.
While all the different valuation methods have their benefits, the entire process of business evaluation could be better managed by experienced professionals who regularly assist many different types of companies that want to know the precise worth of their business.