7 Things to Know About Business Valuation for Small Business

know about business valuation for small business

There are a handful of common reasons why a business owner needs to do their business valuation.  Some common examples are; looking to sell; looking to merge or acquire another company, needing financing or investors, possible tax purposes, and possible for divorce proceedings. 

Each valuation will be determined by the scenarios mentioned above.  As an example, in a sale scenario, the majority of private small businesses are sold as asset sales, whereas the majority of middle-market transactions involve the sale of equity—each of these sales would require a different business valuation method. 

With all this in mind, now it’s time to explore some of the most common business valuation methods, keep in mind you’ll want to work with a business appraiser to get the most objective assessment of what your business is worth.  Most small businesses are sold as asset sales, whereas middle-market companies are typically equity sales. This is where a certified appraiser can guide you to the best option.  Let’s explore those options.do

  1. Market Value Method – This is the most subjective approach because it compares your business to others in the same market that has sold.  For example, if you have a salon business, an appraiser would research other salons that have sold in your area and compare the market value of your company to theirs.  This approach is a great preliminary start but will ultimately need other methods to be more precise with the value of your business.
  2. Asset Based Method – This method is straight forward and as the name suggest, this type of approach considers your business’s total net asset value minus the liabilities. This is mainly determined on the company’s balance sheet.  
  3. ROI Based Method – This method is based on the profitability of your business.  This method valuates the profit and loss of the business, and as it suggests; determines the rate of return on investment/income.  This method is popular for equity sales and attracting investors.  
  4. DCF Method – Discount Cash Method – This is also known as the income approach. This method values a business based on its projected cash flow, adjusted (discounted) to its present value. 
  5. Capitalization of Earnings Method – This method calculates the business’s future profitability based on its cash flow, annual ROI, and expected value.  This method is inclusive of the first three methods.  
  6. Multiple Earnings Method – This is similar to the capitalization method, but this includes the potential to earn in the future.  This method includes different multipliers and will vary according to industry, economic climate and other factors.
  7. Book Value Method – This is close to the asset method; the difference is that this method calculates the value of your balance sheet in a given moment.  The balance sheet is used to calculate the business’s equity.  This method may be helpful if you have low profits.  

Although understanding the different business valuation methods is important, if you do need to evaluate the worth of your business, it’s best to work with a professional. Although the approaches may seem simple enough on the surface, as we saw with the DCF example above, there are extensive and complex calculations involved in determining the value of a business.

This being said, not only will a professional be able to offer you an objective examination of your business, but they’ll likely be able to combine multiple business valuation methods to get you the most thorough sense of what your business is worth.