3 Business Valuation Methods Entrepreneurs Must Know

What is your business worth? You might need to determine this value for a number of reasons, including when you’re seeking investors or other types of small business financing. Or maybe you are deciding to sell your business and need to understand what it’s worth as you enter the M&A process. That’s the job of business valuation services for small businesses.

We’ll teach you about the three major methods all entrepreneurs should know, and why business valuation services might be essential for your small business in Denver and Detroit.

Why Are There Multiple Methods?

Put simply, all methods are ways to determine how much your business is currently worth. Included in these calculations are the values of your equipment, inventory, property, liquid assets, and anything else of economic worth that your company owns. Other factors that might come into play are your management structure, projected earnings, share price, revenue, and more.

Different methods will come in handy in multiple scenarios. Of course, you’ll need to use them if you’re in the process of selling your business. However, you’ll also need to consult them for other situations, such as establishing partner ownership percentages, when seeking financing, or even in divorce proceedings.

1. Asset-based business valuation methods

Sometimes referred to as the cost-based methods, these business valuation methods estimate the value of a business as the sum total of the costs required to create another business of equal economic utility. Asset-based business valuation methods are useful for accurate business purchase price allocation, an important element of structuring a business acquisition deal.

The central methods under the asset approach are these:

  • Asset accumulation method
  • Excess earnings method

The asset accumulation method is a framework for tabulating the market values of business assets and liabilities. The difference is the business value. Note that the method differs from the typical cost basis accounting balance sheet.

Important off-balance-sheet assets include the internally developed intellectual property, customer lists, and valuable business agreements. On the other side, the method accounts for contingent liabilities such as pending legal action judgments and costs associated with regulatory compliance. A classical asset-based business valuation method is Capitalized Excess Earnings, also known as the Treasury Method. In addition to business value calculation, this method lets you determine the value of business goodwill.

2. Market Value Business Valuation Method

A market value business valuation formula is perhaps the most subjective approach to measuring a business’s worth: This method reaches the value of your business by comparing it to similar businesses that have sold. Of course, this method only works for businesses that can access sufficient market data on their competitors. It’ll be a particularly challenging approach for sole proprietors, for instance, because it’s difficult to find comparative data. You won’t have a public database to go by.

Professional business appraisals often include these market valuation methods:

  • Guideline publicly traded company method
  • Comparative transaction method

As this small business valuation approach is relatively imprecise, your business’s worth will ultimately be based on negotiation, especially if you’re selling your business or seeking an investor. You may be able to convince a buyer of your business’s worth based on immeasurable factors, but a savvy investor can see through that.

All that said, this valuation method is a good preliminary approach to gain an understanding of what your business might be worth, but you may want to bring another approach to the negotiation table. That brings us to the asset- and ROI-based approaches.

3. Discounted Cash Flow Analysis Approach

Discounted Cash Flow (DCF) analysis is an intrinsic value approach where an analyst forecasts the business’ unlevered free cash flow into the future and discounts it back to today at the firm’s Weighted Average Cost of Captial (WACC).

A DCF analysis is performed by building a financial model in Excel and requires an extensive amount of detail and analysis.  It is the most detailed of the three approaches, requires the most assumptions, and often produces the highest value. However, the effort required for preparing a DCF model will also often result in the most accurate valuation. A DCF model allows the analyst to forecast value based on different scenarios, and even perform a sensitivity analysis.

For larger businesses, the DCF value is commonly a sum-of-the-parts analysis, where different business units are modeled individually and added together. To learn more, see CFI’s DCF model infographic.

Other Business Valuation Methods To Know

  • Capitalization of Earnings: This method calculates a business’s future profitability based on its cash flow, annual ROI, and its expected value. The Capitalization of Earnings valuation method works best for stable businesses, as the formula assumes that calculations for a single time period will continue.
  • Multiples of Earnings: Also known as the Times Revenue Method, this formula calculates a business’s maximum worth by assigning a multiplier to its current revenue. Multipliers vary according to industry, economic climate, and other factors.
  • Book Value: Don’t forget about this method, too, which we mentioned earlier. This formula calculates the value of the business’s equity (or total assets minus total liabilities), as per the business’s balance sheet.

Business Valuation Services for Entrepreneurs and Startups

Business valuation services provide the business owner with multiple facts and figures regarding the actual worth or value of the company in terms of market competition, asset values, and income values. This information is something that all business owners should have available. Obtaining a business valuation should also be completed yearly to display company growth.

Once your business’ valuation has been established, set new goals to increase the company’s value over the next year. Every year, you should set time aside to compare the previous years’ valuations to measure growth, losses, and notice where room for improvement is. Knowing what every component of your business is worth through business valuation services is invaluable information for business owners to have.

Business Valuation Services in Detroit and Denver for Small Businesses & Startups

Not only do owners need to understand what their business is worth today, but they also need to know what supports and drives that value. Far too often, owner overconfidence or apathy causes this step to either be neglected or downplayed or at a minimum, based on incomplete data or conjecture.  In this case, business valuation services can serve as a reality check for owners with a biased or uninformed viewpoint on what their business is worth. Schedule a free consultation TODAY with our business valuation experts in Detroit and Denver.