Business Valuation - A Primer
How much is my business worth?
Business valuation methods can be intimidating. This business valuation article covers how to value a business and some of the more common business valuation methods.
Determining the value of your business is probably one of the most difficult things you will be required to do as an entrepreneur.
There are a number of reasons why you might need a fair and accurate assessment of how much your business is worth ranging from determining a selling price to raising investment capital.
From the outset, it's important to note that you - the business owner - are the person least capable of deciding how much your business is worth. Business owners have a personal and emotional stake in their companies. Instead, you will need to rely on objective methods for determining your business' value.
Business owners use several methods to determine the value of their businesses. The method that is right for your business will depend a lot on the type of business you own and the standard for determining values in your industry. The most common methods of business valuation include the following:
- Rule of thumb method. One of the most widely used forms of business valuation is based on the rule of thumb method that determines value according to a standard for businesses in the same industry. Every industry has benchmarks that industry insiders use to gauge the value of their businesses. The problem is that the benchmarks are based on industry averages and don't take into account the extenuating circumstances of any given business. So, while the "rule of thumb" method is good for ballparking the value of your business, you will need to rely on other methods to determine its final value.
- Book value method. The book value of a business is based on the accounting records and is determined by subtracting the company's liabilities from its assets. The result is the owner's equity or book value of the business. Adjustments are then made for things that aren't reflected in the financial statements like intangible assets and market factors.
- Earnings capitalization method. The earnings or income capitalization method is based on determining an annual rate of return necessary for taking on the risk of the investment. Rates of return vary according to the amount of risk involved, but many small business owners expect to see a 20-25% annual rate of return on their investment. According to this method, the value of the business is determined by the size of the investment necessary to earn the required rate of return when it is compared against the business' historical earnings.
- Tangible assets method. Sometimes a business' worth is determined exclusively by the value of its tangible assets. Tangible assets include those things that can be seen or touched such as inventories, equipment, real estate, etc. In many cases, tangible assets will be purchased by other companies in the same industry based on an appraisal of the asset values.
You may find it helpful to consult an expert to help you determine the value of your business. This is especially true if your business has a significant amount of intangible assets. But even then, the true value of your business can only be decided by how much someone is willing to pay for it in the marketplace.
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