Business owners often confuse business value with the sale price. Having a good understanding of the value of your business is critical for key business decisions.
A business valuation provides an opinion of the ‘fair value’ of your business (and/or equity if applicable) at a point in time. The valuation process considers a suitable approach (either income approach, market approach or asset-based approach) and then selects the most appropriate valuation methodology for the business in question. Commonly accepted methodologies include capitalisation of future maintainable earnings, discounted cash flow and net tangible assets.
While the discounted cash flow methodology is accepted within the industry as probably the purest method of valuation, it is less commonly used in the small to medium enterprise (SME) space due to the requirement of precise knowledge of all cash inflows and outflows of your business from inception to the end of its life.
A modification of this method (the capitalisation of future maintainable earnings method) is most commonly used for valuing mature commercial businesses with a history of profitable trading and an expectation of continued profitability. This methodology involves capitalising the earnings of a business at a multiple which reflects the risks and opportunities of the business and the stream of income that it generates.
To arrive at an appropriate multiple (or capitalisation rate), the valuer needs to understand your business thoroughly, including its key drivers, competitors, customers, market position and other factors – as well as a demonstrated knowledge of the relevant accounting standards. The valuer will then build a risk profile with which to assist in determining the appropriate multiple.