Multiple business valuation methods can be used to determine a business’s value. Although several methods are considered standard, when compared to each other, one business valuation formula will undoubtedly result in a different value than another formula. Add to that the wide variation of industry-specific factors, and you can understand why valuing a business is really more of a craft than a set of hard and fast rules.
With this in mind, it is important to use multiple business valuation methods to gain a full view of a business’s value. No business valuation formula is perfect, so always use a valuation with more than one valuation method to determine the most accurate price for a business. Here, we will lay out four standard business valuation methods and how to approach each.
#1 Asset-Based Business Valuation Methods
Asset-based business valuation methods center on your company’s book value. Consider your company’s total net asset value, less total liabilities, according to your balance sheet. This may sound clear cut, but the water can get muddy when you begin adding the value of intangible assets like branding, copyrights, trademarks, and customer lists. There are two main approaches to an asset-based valuation:
This approach applies to businesses that expect to continue operating and growing. After referring to the balance sheet, negotiations will likely focus on the assumed value of those intangible assets.
Going Concern Business Valuation Formula:
Total Tangible Assets + Total Intangible Assets – Total Liabilities = Value
This approach applies to a business that is closing and liquidating its assets. This is an important distinction from the Going Concern approach because the liquidation value of assets is typically below fair market value.
Liquidation Business Valuation Formula:
Total Tangible Assets – Total Liabilities = Book Value
#2 Earnings-Based Business Valuation Methods
Earnings-based business valuation methods value your company by its ability to be profitable in the future. This method is best suited for stable, profitable businesses, and there are two main approaches:
Capitalization of Earnings
The Capitalization of Earnings business valuation formula assumes the calculations for a single time period will continue and calculates future profitability based on cash flow, annual ROI, and expected value.
Capitalization of Earnings Business Valuation Formula:
Net Present Value / Capitalization Rate = Business Value
Multiple of Earnings
The Multiple of Earnings method, like the Capitalization of Earnings, values a company by its future profitability. However, this formula calculates the business’s worth by assigning a multiplier to its current revenue. The appropriate multiplier will vary widely depending on your specific industry, current market trends, and the economic climate.
Multiple of Earnings Business Valuation Formula:
EBIT or EBITDA x Appropriate Industry Multiple = Business Value
#3 Income-Based Business Valuation Methods
The income-based valuation method is also known as the Discounted Cash Flow (DCF) method. This method requires careful calculations and, most likely, a business consultant. Best suited for businesses with a large potential for growth, value is based on your business’s projected cash flow, which is then partially discounted to account for risk.
DCF Business Valuation Formula:
Cash Flow Forecast – Discount for Risk of Future Losses = Present Value
#4 Market-Based Business Valuation Methods
Market-based business valuation methods determine the value of your company by comparing it to similar businesses that have sold. The helpfulness of this comparison depends, of course, on your access to sufficient market data on your competitors, and sufficiently comparable competitors at that. Because of the difficulty in comparing, there are many limits to this method, but there are two main approaches:
In a sales-based approach, you will compare your company’s revenue to the sales of a similar company that has recently sold. This information is used to calculate a sales multiple. For example, if the competitor’s revenue was $1,000,000, and that company sold for $500,000, that equates to a 0.5x sales multiple.
Sales-Based Business Valuation Formula:
Revenue x Sales Multiple = Business Value
In a profit-based approach, you will compare your company’s profits to the profits of a similar company that has recently sold. This information is used to calculate a profit multiple. For example, if the competitor’s profits were $300,000, and that company sold for $1,500,000, that equates to a 5x profit multiple.
Profit-Based Business Valuation Formula:
Profits x Profit Multiple = Business Value
Whether you’re thinking of selling your business or just want to know how much your business is worth, it’s critical to recognize that many different factors play into how to value a business, and these factors vary significantly by market and industry. If you’d like more industry-specific information, be sure to visit our page of business valuation methods and selling tips by industry.
Remember, regardless of the industry, no business valuation formula is perfect, so always use more than one to determine the most accurate price for your business. Better yet, reach out to us! Request a custom valuation of your business for the most accurate picture of what your business would likely sell for, and how long it might take to complete the transaction.