You’ve operated your widget manufacturing business for over a decade and now you’re considering selling it and possibly moving to Honolulu to enjoy your hard-earned money. But then comes the million-dollar question: what is the business worth?
Unfortunately, there isn’t one golden formula to determine the value of a business. There are several methods available for calculating enterprise value and ultimately the most appropriate method will depend on your company’s unique strengths, including market, historical and projected cash flow, asset-base, liabilities, etc.
Here are 3 common valuation techniques that can help you get started: (1) asset-based, (2) income-based, and (3) market-based.
Asset-Based: One of the most basic ways of understanding a company’s value is to determine its “net-asset value”. In other words, the value is generated by subtracting the company’s total liabilities (recorded and contingent) from the company’s total assets (tangible and intangible).
Income-Based: In the income-based valuation method, the value of the company is determined based on the amount of income the company can generate in the future.
Two common income-based approaches are “Capitalization of Earnings” and “Discounted Cash Flow”. In very simplified terms — the Capitalization of Earnings method is typically used if future profits are expected to remain stable and the value of the business today is determined based on its future profitability. Whereas, the Discounted Cash Flow method is typically used if the future cash flow is unpredictable. Here the company’s future cash flows are discounted to determine the value of the company today.
Market-Based: With the market-based approach, you value your business using the average of similarly situated businesses in the same or similar industries. For instance, you will determine how much similar widget manufacturing businesses in Arizona would sell for if it were sold. Although this approach may appear simpler, this approach may not be appropriate for all businesses, especially if there is insufficient data available or if other similarly situated businesses are sold at a lower price (e.g., due to poor economic conditions).
It’s always best to use different valuation methods and draw a comparison before determining what method is best suited for your company.