Business Valuation: Why and How

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by Advice Chaser
by Advice Chaser
low angle photo of city high rise buildings during daytime

Has someone told you your business needs to have a valuation done? It might sound simple, but the reality can be complex. Unlike a car or house, you can’t simply look up comparable ones on the internet. And you can’t just look at the balance in your business’s bank account—that’s not enough.

The good news is, professionals do business valuations all the time. There are several different ways to calculate the value of a business, but all of them can be useful when it comes to figuring out what your business is worth.

Why Do a Business Valuation?

The most obvious time to do a business valuation is when you’re planning to sell it. Obviously, you’ll need to know how much to ask for, and the buyer will want to know the value of the product they will receive.

However, that’s not the only reason for assessing the value of your business. You may need to do it when you add a partner, when a partner wants to leave, when you need to know the value for tax purposes, or when you’re seeking a loan. It may also become relevant in divorce proceedings.

That said, valuing a business costs money, and it doesn’t have to happen every year. Do one when you have a reason, or periodically to keep tabs on what you have.

Types of Business Valuations

Not all methods of valuing a business will come up with the same number. After all, a business is a living and changing organization, constantly taking in money and spending it. Know the types of business valuations, and make sure you know what method will be used for yours.

Asset-based approaches

Much of the value of a business comes from its assets. Assets minus liabilities equals the value of your business. But even this method can vary some. A going concern asset-based approach, or book value, lists the total assets and subtracts liabilities like debts. A liquidation asset based approach considers what money would be left if all the assets were liquidated and the debts settled. 

Clearly, the two approaches aren’t quite the same. Some of your assets, like your company’s brand, can’t be sold.

If you’re a sole proprietor, you’ll have to work out which of your assets belong to the company and which you own personally. Legally, you don’t have to keep them separate, but you should consider which assets would go with the company if you sold it.

Earning value approaches

A business is more than just the sum of its assets. What about the amount the business could be expected to earn yearly?

Capitalizing past earnings involves working out what the company has earned in the past, averaging that number while ruling out unusual events, and multiplying by a number intended to show the likely rate of return (the capitalization factor).

Discounted future earnings is a projection of possible future earnings divided by the capitalization factor.

Market value approach

This approach is intended to tell you what the business might be worth on the market. As with selling a house, finding comparable businesses that have sold recently can be helpful. If there are many businesses like yours in your area, it shouldn’t be too hard. But if your business is unique, or if there isn’t public data available on similar businesses, this approach might not work for you.

Who Can Do a Business Valuation?

Because of the conflict of interest involved, you can’t value your own business except for your own information. A buyer would have no reason to trust that your valuation was accurate. Instead, you’ll need to hire someone with the appropriate credentials. In the US, that will usually be someone with the Accredited in Business Valuation (ABV) credential. Someone with an ABV is a certified public accountant (CPA) who also has extra education and experience. They have to pass an exam and continue working and learning in the field.

In Canada, you might instead hire a CBV, a chartered business valuator.

How to Start

Contact us to find a financial advisor who works with businesses. With their advice, you can decide if you need a business valuation and who to hire to do it for you. You can also learn what type of valuation will work for your business.

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Business Valuation: Why and How

There are different ways to calculate the value of a business, but all of them can be useful in figuring out what your business is worth.

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