|
As a business owner, you know more about your business than
any one, but there is one thing you are not too sure about - how much it is
worth. This is the first in a series of articles designed to help you learn
about business valuation and, if you choose, do your own business valuation.
Defining Value
Before we begin discussing business valuation it is
important to define what value is. When asked, most people will struggle to
define it then end up using an example like a one dollar bill is worth more
than a quarter. Value is difficult to define without comparing at least two
items. The comparisons must be well defined to have any meaning. For example a
rare quarter may be worth more than a common dollar bill. The first step in any
valuation is to accurately and completely define the property that is being
valued.
Value is also subjective.
Someone who needs a quarter to plug a parking meter in order to avoid a
parking ticket would gladly pay a dollar or more for a quarter. Similarly, one
business may have a number of values. A strategic buyer that can plug the
customers of the business into its existing system may perceive more value than
a person who is going to run the business day-to-day. The second step in
valuation is defining for whom the property is being valued.
What is a Business Valuation?
A business valuation is simply an estimate of what a
business is worth based its hypothetical sale. It may also be called a business
appraisal and has some similarities with real estate appraisals. A big difference is that much of business
value is in the form of intangible assets, or goodwill. Valuing intangible
assets involves a process of using various accepted valuation approaches and
methods. The goal is to determine a value that can be explained and justified
to others.
How Much is a Business Worth? In theory a business is worth the present value of all the
future benefits of owning the business. Present value is the process of
discounting the value of cash or other property to be received in the future to
its current value. There are many benefits (cash and non-cash) to owning a
business. Valuation focuses on the financial benefits defined as earnings or
cash flow. The rate at which the future benefits are discounted must account
for all the risks associated with owning and operating the business. Basically
the value of a business comes down to the classic investment paradox - risk vs.
return. Basic Valuation Methods
There are 3 primary approaches to valuing a business -
market, income and asset. The market
approach uses data from actual sales of similar businesses or from publicly
traded companies to value a business. The market approach is the preferred method.
The biggest problem is that good quality, comparable data is seldom available.
The income approach looks at the earnings or cash flow of a business as the
primary driver of its value. It is the most commonly used method and works well
unless a business has little or no earnings. The asset approach tries to value
each part (asset) of the business separately. The sum of the parts is the value
of the business. This method works well with tangible assets, but not for the
intangible ones. The methods of identifying and valuing individual intangible
assets are highly theoretical and often produce unrealistic results. The asset
approach is often used when a business has few intangible assets, or little or
no earnings.
Conclusion
Knowing how much your business is worth is a critical piece
of information that every business owner should know. The remaining parts of
this series will explore and explain the business valuation process so you can
do your own business valuation. |
