When thinking about our major assets – our investments, our homes, perhaps our cars – most of us have a pretty good idea about what they are worth. But when it comes to the value of a company – arguably the biggest assets many of us will ever own – very few people are confident that they know what it could be worth.
Given that the 海角视频 is a nation of entrepreneurs – – this is something that is relevant to a huge number of people.
Why do I need to know the value of my business?
There are several reasons why a business owner needs to know the value of their company. The most obvious reason is because they are looking to sell and need to know, firstly, if it makes financial sense to sell, and secondly, to establish a negotiating position.
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But selling is not the only reason you might need to know the value of your business. For example, you would need to obtain a valuation if you decided to grant share options to long standing employees, set up employee ownership trusts or are considering a management buyout. On a less positive note, a valuation would also be needed in the case of a divorce, or if the business’ assets are being divided between beneficiaries.
Another major reason why you might need to obtain an accurate valuation of your company is in order to track its progress against its - or your own - strategic goals. Given that the vast majority of business owners (99%) employ less than 50 people, and in most cases, employ no one other than themselves, the value of the business is almost always heavily linked to personal finances, often forming a significant proportion of the owners’ net worth and consequently, a sizeable part of their long-term financial plans. Therefore, determining the value of the business will help the owner understand if it is able to help them fund the lifestyle they want in later life. If the valuation shows that it will – fantastic – and if the company isn’t where it needs to be to provide the retirement the owner hoped for, a valuation offers the opportunity to seek expert help and advice about what needs to be done to grow the businesses to ensure it can be sold for the price needed.
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How do I work out what my business is worth?
The first thing to highlight when talking about value – especially the value of a business – is that there are lots of different methods, and the value will differ quite significantly depending on the method used.
For example, trading companies do not tend to hold significant stock or cash in excess of their working capital need. That is because it is more efficient to re-invest profits to drive growth or generate returns, which means valuation based on assets would not be as accurate a valuation that assesses earning potential.
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On the other hand, if you were to value an asset-heavy firm, for example, a property investment company, a method that uses income as a marker would not be as accurate as one that uses assets to determine worth.
Therefore, it is crucial that when you are looking at valuing your company, you use the most appropriate methodology to do so.
Income based valuations
Discounted Cash Flow
Often regarded as the ‘gold standard’ income-based valuation method, discounted cash flow calculates the value of a business based on ‘discounted’ future earnings, using forecasted information. The reason the future income is discounted is down to the ‘time value of money’, i.e. it is better to have £1 now than in a year’s time, because factors such as inflation – particularly relevant at the moment - and the fact that £1 could be invested and earn returns, means £1 is more valuable now.
Generally, private companies are not held to the same rigorous accounting requirements as quoted companies, which makes forecasting future cash flows difficult, and then even when you do have these forecasts, there is no formula for calculating the ‘discount rate’, so you need to make a number of complex judgments and assumptions. This means two discounted cash flow valuations of the same business could differ by up to 25%. As a result, this method is not used a huge amount.
Capitalised Earnings
The most commonly used method to value a private business is capitalised earnings. It is often regarded as a ‘simplified’ version of the discounted cash flow because, instead of trying to forecast future earnings, it uses historical results to calculate a ‘maintainable earnings’ figure. Based on the theory that the company’s future income is likely to be related to its past performance, the value of the company is calculated by multiplying its ‘maintainable’ earnings by what is known as an ‘earnings multiple’. Again, this relies on certain assumptions, but generally the multiple is between three and eight – depending on the company, its past performance, its growth record, the sector it is in and any wider economic factors that could impact its future income. In general, smaller or riskier businesses would attract a low multiple, and large, stable or high growth companies would attract higher multiples.
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Turnover
Another income-based valuation similar to capitalised earnings is turnover. Again, similar to discounted cash flow and capitalised earnings, this income-based method calculates a business’ value using a multiple, but this time, of its turnover. This is a common method for professional services firms that have recurring fees, or start-up companies that may be loss making whilst they build their customer base.
Asset based valuation
Net Assets
There is really only one asset-based valuation method - Net Assets. As mentioned earlier, this method is generally used for asset-heavy businesses and, given that all companies have to disclose their net asset position as part of their annual financial statements, it is relatively easy to determine a good starting point for this type of valuation.
However, the net asset value disclosed as part of financial statements is usually based on historic assets information, and therefore, cannot be relied upon as it will not necessarily represent the current value of a businesses’ assets and liabilities. As a result, when using an asset-based valuation, most businesses will also use a panel of independent experts - such as chartered surveyors - to provide formal valuations of key business assets such as land, property, machinery and stock, and this information is then used to calculate the net asset valuation of the company.
Whether you are looking to sell, secure investment, set up share options or determine if your business is on track to meet its strategic goals, you will need to determine its true value.
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