In this article, various business valuation methods are discussed.
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This article is the second in a series, continuing our discussion on business valuation methods discussed in Valuating a Business.
These valuation methods will help a small business owner determine a ballpark range for the value of their business entity. In addition, it is a great way to prepare for potential buyers, as most buyers will utilize one of these valuation methods.
Many of the valuation method are based on the businesses' cash flow. This is due to the fact that a business that requires less debt to operate is more attractive to a potential buyer than a highly leveraged firm. A few of the cash flow valuation methods are discussed below.
Discounted Cash Flow
This valuation method is based on the fact that a dollar today is worth more than a dollar in the future, due to inflation and other considerations. Clearly, a dollar today could generate future earnings, so a dollar tomorrow is less valuable than a dollar in hand today. With this method the company's future projected earnings are adjusted for inflation, real growth and risk. The value of the company is determined based on the results.
Cash Flow Method of Valuation
This valuation method is based on how large of a loan the company could receive based on the business' cash flow. In order for a small business to grow, they will likely require loans. How well the company's cash flow performs will directly impact how large of a loan the company could obtain. This cash flow figure is adjusted for depreciation, equipment replacement and amortization. The total amount of the loan is the value of the business.
Debt Assumption Method
This valuation method usually gives the highest value for the company, so a small business looking to sell should try to utilize this method. This figure is determined by how much debt a company could take on and still operate, using the firm's cash flows to pay off the debt.
This list of valuation methods is certainly not exhaustive. It's important for a small business owner to understand that there are a variety of different valuation methods and a company is worth different amounts depending upon the circumstances and who is looking to purchase the business.
If you are looking to sell your business, your company will have a higher valuation to a buyer who has synergies with your business. For example, a large corporation that sells circuit boards will be willing to pay more for a company in the electronics business than a food manufacturer.
If you are looking for a loan, being familiar with various valuation methods is important. By understanding what your company is worth and how it will be evaluated by outside parties, you will be better prepared to discuss and comprehend different values for your company.