How to Approach Valuation for Your Company

When you sell your business, you need to get the price right. If it’s too high, no one will bite. If it’s too low, you’ll get less than you should. Setting the right price, however, is not easy. You need to know the valuation of your company.

Most sellers need to draw upon the expertise of an Investment Banker or M&A Advisor. Several strategies can help you prepare documentation that supports the process while arriving at your own ballpark estimate.

Estimate the Value of the Business’s Tangible Assets

This strategy is most effective for businesses with lots of capital, but can also be beneficial to small businesses. List all of the physical assets, such as equipment, furniture, and inventory. Then analyze the age, condition, and cost of acquisition. For most businesses, this figure reaches something less than the actual value, since it doesn’t take into account cash flow, reputation, and other valuable factors. But it can help you move in the right direction.

When valuation is complete, compare the valuation you derive from other methods to the value of tangible assets. If the values are similar, an asset liquidation or sale might be the most cost and time-effective way to exit the business.

Use an Earnings Multiple to Estimate Value

Multiples are ratios of the business’s value to financial indices such as cash flow and revenue. The right multiple varies with the type of business, location, and other factors. In most cases, the value is between one and four times the value of cash flow. Consider questions such as:

  • Are profit and revenue trends positive?
  • Does the business include exclusive products?
  • Is the business the only provider of your products?
  • Can other businesses start similar businesses?
  • Do you have recurring or passive revenue?
  • Do you have a respected brand or reputation?

If you can answer in the affirmative, it likely justifies using a higher multiple. Business sale sites often offer easy to use tools that enable you to look at the prior sale and multiple values of businesses similar to yours. This data can inform your choices.

Assemble Financial Documents to Support an Income-Based Valuation

A reliable valuation requires the assembly of financial documents for this year and the previous three years. You might need a bookkeeper to help you gather these essential documents, which include:

  • An income statement listing gross revenues, bottom line profits, and expenses.
  • Cash flow statements demonstrating how money moves in and out of the business.
  • Balance sheet listing the value of tangible assets, as well as liabilities.
Prepare a Discretionary Earnings Statement

Partner with your accountant to reformulate business income into a statement of owner cash flow or discretionary earnings. The income statement represents the range of normal and legal deductions, the seller’s discretionary earnings (SDE) or cash flow statement presents the business’s earning power. This is often a key concern for potential buyers.

Identify Trends Represented in the Financial Statements

You must understand the trends represented in several years of financial documents to understand whether or not your business is growing and how it is earning revenue. These trends can significantly affect your final asking price.

Perform an Income-Based Valuation

Most experts see an income-based valuation as the best way to value a business. It’s also the most complex. Most owners prefer to use an Investment Banker or M&A Advisor who can create a valuation with this approach. Assembling financial statements and analyzing trends better equip you to understand and be comfortable with the valuation an appraiser provides.

A professional valuation expert costs money, but it’s money well spent. If you can’t get set the right price, you may not attract buyers, or you could lose money.