Business valuation is an inevitable first step in selling your company. It gives you a point from which you start the price negotiations with a seller. Learn more about this important step in this post.
Understanding business valuation is an indispensable part of what a business owner needs to do when selling a company. After all, it’s the valuation process that determines a business price. However, the seller also needs to understand that company valuation doesn’t determine the final purchase price. It is only a tool for assigning value based on revenue, assets, market position, and other factors.
If you’re a seller who wants a better idea of what goes into the assessed value, read on and discover the different areas of business valuation for beginners.
Search for terms like “valuation businesses for sale,” and you’ll discover that professionals look beyond how much the company produces during valuation. Each performance-supporting factor that determines a business value is also included in the calculation.
We’ve already established that financial statements are tools accountants and brokers use at the start of the valuation process. In these points, a business owner can see the specific areas showing how financial statements reveal data and how they are applied in valuation approaches:
Part of what you’ll learn in this business valuation for beginners is that a business’s worth relies upon core components. Relying on book value (a calculation that only factors in the assets and liabilities) isn’t going to cut it. For a company valuation to be realistic, it needs to consider financial factors and non-financial areas that contribute to the company’s earnings. Here is a short list of some of the components you’ll often see within a valuation:
Assets, in most cases, greatly impact the valuation. But how they increase or decrease business value depends on the following factors:
Tangible assets (e.g., equipment, vehicles, or buildings) and intangible assets (e.g., IP or established brand name) are listed on the balance sheet and subject to tax depreciation and amortization, respectively, based on their useful life. Different valuation approaches assess the worth of these asset types in unique ways. While tangible assets contribute to production and operations, intangible assets support demand and scalability.
Why are they considered? To put it simply, evaluating a company’s assets and liabilities, both physical and non-physical, is needed to present an accurate and competitive valuation for the sale of a company.
Unlike publicly traded companies that are valued through market sentiment or an approach called market capitalization, private businesses rely on fundamentals like customer retention and competitive standing. Having a solid understanding of customer relationship management is expected of any business owner working toward company valuation. When they make it a point to establish a customer base that’s loyal and diverse, potential buyers will view it as a stable company. It’s a signal that the investment is low-risk with better chances at long-term growth.
In understanding business valuation, it’s clear why market position matters: Strong brand presence and customer loyalty drive profitability and reduce marketing costs.
The valuation process takes into account various factors. So, when it comes to assets and liabilities, there are two things a business owner needs to remember:
In this beginner’s guide to business valuation, business owners will understand basic financial terms and metrics that are particularly important to the valuation process and the sale of a company. You will further explore how financial statements, net income, and EBITDA are part of the calculation of valuation approaches that look at internal factors.
Are you truly prepared for a sale? Any business owner can answer this question after a company valuation, a process that makes them aware of the company’s financial standing.
The next question is: “How do I know the company’s financial position?” Simple: You will always refer to your financial statements.
The following points specify items within your financials and how they impact the bottom line, which is selling your company:
Metrics that are considered central to calculating financial performance in various business valuation methods are the following:
Remember: Different valuation approaches may favor one over the other, depending on the buyer’s focus. Let’s take a look at particular examples:
In guides about valuation for beginners, financial metrics take center stage in the company value calculations. Our quick list below shows some of the specific metrics from financial statements used for business valuation:
Not everything on financial statements is calculated at face value. Reflecting the real value of the company means making necessary adjustments to those figures in different business valuation methods. One major adjustment brokers often apply is for tax depreciation and amortization.
Let’s say you want to sell agriculture company you’ve been running for the past 25 years. During the valuation process, the broker points out that not everything on your financial statements reflects true business value as-is.
Any beginner’s guide to business valuation will tell you that the most used valuation approaches are the following:
They may have varying steps to calculate, but each approach has one goal: to arrive at a number that’s realistic and fair. These methods also have different focal points. It’s best to choose a broker with experience within your industry or who has valued a similar company so they can perform using the best method.
Among the valuation approaches, the asset-based method is often used in a company valuation where earnings can’t be normalized or where intangible assets like goodwill have little to no presence. This approach focuses on the value of a business’s tangible assets, which are listed on the balance sheet, minus its liabilities. Brokers want to get the net asset value by performing the adjustments we’ve discussed above, which factor in tax depreciation and amortization, as needed.
Industries where companies operate using mostly tangible assets (e.g., heavy machinery in factories) typically undergo this kind of valuation method because the worth is heavily reliant on property rather than earnings. In some cases, the business may be operating at a loss or preparing for liquidation. That’s when the asset approach becomes one of the most practical business valuation methods available.
Construction companies, for instance, often require equipment appraisals to reflect the real value of their machines on the balance sheet. While income isn’t the strongest point, the value is apparent when assets and liabilities are considered.
Consider these questions to determine whether asset-based valuation best applies
The bottom line is that the asset-based method is the way to go when the priority is a grounded result that looks at the real worth of the company.
Consider the following questions to know if it’s best to use the income approach among the most common valuation approaches:
“Yes,” to both questions means that the income approach is the way to go. This forward-facing approach looks at projections and turns them into the company’s current value. Profitable businesses, which are typically service-based, are valued using the income approach.
Before applying either method, analysts perform normalizing adjustments. These remove unusual, one-time, or discretionary items from the income statement to reflect earnings from regular operations.
This approach is especially useful in business valuation methods when valuing companies with stable operations and scalable income models. The cleaner the earnings data, the more accurate the income-based value becomes, making this a key approach for going-concern businesses.
The market approach answers this question:
A company valuation method relying on real-world data, the market approach is one of the most widely used valuation approaches.
How does it work?
Two common business valuation methods fall under this approach:
The approach is especially applicable when the company is in a prominent sector.
Are you a small business owner looking for a guide to business valuation?
The good news is that there are business valuation methods so simple, you can perform them yourself. Understanding business valuation for beginners isn’t too difficult if you start with basic methods like asset valuation and revenue multiples.
Online businesses and SaaS companies are often fast-growing businesses. If your company belongs to these types and you’re looking to sell it, you’ll likely use the revenue multiples method as your company valuation approach. Arrive at its value by using an industry-specific multiplier. Some points to note:
If your company is the following:
Then, the ideal way to calculate value among business valuation methods is the asset valuation approach. Performing this is simple: You list all tangible assets and intangible assets from your balance sheet, then subtract liabilities.
The asset-based valuation method is one of the simplest business valuation methods. This gives a snapshot of value based on the company’s actual resources, its assets and liabilities. It’s often used when potential buyers want a baseline company valuation.
Earnings-based methods are common business valuation methods that estimate worth based on a company’s income. Before you sell your business online, you should value your company. You typically begin with net income and adjust it to calculate EBITDA, a clearer measure of operating profit.
Two popular earnings-based approaches include:
These methods reveal how much value comes from earnings performance.
A business owner who’s aware of the valuation approaches will know what brokers, and eventually, potential buyers, are looking for. They know how to prepare financial statements for the upcoming valuation process. What can a seller expect during preparations? We discuss them all in this section.
With the valuation process being the initial step on your path to selling your company, as a business owner, you need to make sure that your financial statements (balance sheet, cash flow statement, and P&L) are ready for the process.
But what exactly are the preparation steps? Let’s say you’re a company in Georgia. Before you contact Georgia business brokers, your financials from the last 3 to 5 years should be cleaned and organized. Well-prepared financials, including a list of assets and liabilities, lead to a more accurate valuation outcome.
A business owner can treat the valuation process as a preparation for the due diligence process, which starts when the owner agrees to the prospect’s offer. During the company valuation, the seller needs to practice transparency at all times, especially when the broker is running through the financial statements.
Expect the broker to use multiple valuation approaches. Why is this important? Because achieving an accurate result is only possible when the business valuation methods used factor in internal and external variables.
In this guide to business valuation, we will also reveal the perks of having a company valuation. The good news is that the business owner will not only determine the asking price. The results will reveal the areas where you can make improvements to achieve a better valuation when dealing with potential buyers.
A business owner about to go through a company valuation needs to remember three things when enticing potential buyers:
Hence, they need to see the following for your company to be a worthy investment:
After the company valuation, a business owner can see areas of the company that require improvement. The good news is that brokers can deliver excellent information regarding value maximization, whether it’s strengthening the protection of your intangible assets or expanding your customer base further.
Work with the right broker who knows your industry or the vertical you operate in. They know which aspects attract potential buyers that could potentially tip negotiations to your side.
A maximized valuation is always the goal. But it’s not enough to fix your operations to achieve excellent results from different business valuation methods. How do you make an exit at a satisfactory purchase price?
Assuming you will be initially performing the company valuation on your own, keep these in mind:
Mistakes could be costly in the field of M&A. Make a mistake in your valuation process, and you could be missing out and accepting terms lower than your company’s actual value. Covered in the points below are some of the most common errors:
We’ve reached the end of a guide to business valuation and pointers on business valuation for beginners. Understanding business valuation when the actual process happens gives you more control, clearer expectations, and a stronger position when it’s time to sell. Discussed in the remaining sections are some key takeaways.
Understanding business valuation gives you points on what to anticipate during the due diligence process. As the business owner, your role is to accurately describe your company according to what’s presented and stated on your financials and operational documents. When you know how to answer each question from potential buyers, you increase the chances of successful selling outcomes.
This beginner’s guide to business valuation has walked you through the basics, but more importantly, it’s about building your footing as an owner. The more valuation knowledge you gain, the more confident you become in making decisions that affect your company’s worth. It’s all part of confidence building.
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