Whether you are thinking of selling your business or just want to know how much it is worth, a business valuation is the single most useful piece of financial information about any business. Many different internal and external factors contribute to the value of a business, and although these factors vary significantly by market and industry, there are five important valuation concepts every business owner should understand.
Five Crucial Valuation Concepts for Business Owners to Understand:
Going Concern Value
Going Concern Value is most relevant for businesses that expect to continue operating and growing indefinitely. This is one of the valuation concepts used in calculating asset-based business valuations, and when referring to Going Concern Value, we mean that the business’s value is expressed in terms of the expected future growth of the business.
Another of the asset-based valuation concepts is Liquidation Value. In contrast to Going Concern Value, Liquidation Value applies to a company that is going out of business and liquidating its assets. A key difference here is that the liquidation value of assets is typically lower than fair market value.
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization” and is one of the valuation concepts required for an earnings-based business valuation. In the Multiple of Earnings formula, the business’s revenue is expressed as EBITDA; then the business’s value is calculated by assigning a multiplier to its current revenue. The appropriate multiplier varies widely depending on the specific industry, current market trends, and economic climate.
Future and Discounted Cash Flows are the main valuation concepts involved in income-based business valuations. Generally speaking, Cash Flow, which takes into account taxes, capital expenditures, and working capital changes, is the true determinant of the business value. Future Cash Flow is then based on the assumption that historical results of the company’s earnings are useful in predicting the future results of the business. Discounted Cash Flow, or DCF, means we apply a discount to the Future Cash Flow value to account for risk.
Transferability of Future Cash Flow
As mentioned above, Future Cash Flow is one of the most critical valuation concepts used in determining a business’s value. But, Transferability of Future Cash Flow can have just as much impact on the worth of the business. How transferable is the company’s Future Cash Flow from the current owner to a potential buyer? When a company’s Cash Flows are primarily controlled and influenced by the owner’s customer relationships and delivery of service, that personal goodwill is not transferable and provides little to no commercial value. In this scenario, if the current owner does not plan to stay after his or her company is acquired, the company’s worth may be limited to its tangible assets. Thus, it is imperative that owners build a strong management team so that the business can run smoothly even without the current owner in place.
If you would like more industry-specific information or a more accurate picture of what your business is worth, contact us today to request a custom valuation.
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