As a business owner, you are likely to come across terms with which you aren’t familiar. Failing to understand common business terms can cause major problems when you make large business moves.
One of the terms you need to understand is business valuation. You also need to understand the types of business valuations in order to best use this knowledge. Continue reading this article to learn about four common types of business valuations as well as what these valuations are used for. You can also enlist the help of a CFO for hire that knows all of this terminology and can guide you through these important processes for your business.
1. Asset Valuation
Asset valuation determines the current value of a company. The current value takes into account the company assets like buildings, brands, goodwill, stocks, and other assets. Asset valuation is often used along with other business valuation methods to build a case for a company’s value.
Use this method to calculate your business’ net worth by adding up the current value of business assets minus the current value of its liabilities. Asset valuation is one of the easiest ways to value a company but isn’t the best way if you want to get the most out of your company.
2. Historical Earnings Valuation
Historical earnings valuation is a business’ gross income. Historical valuation looks at the business’ ability to repay debt and capitalization of earnings or cash flow. Your business’ value is determined by its ability to repay debt and its cash flow.
To improve your business’ value, repay debt quickly and main a positive cash flow. When you want to determine the historical earnings valuation of your business, use all of these factors.
3. Future Maintainable Earnings Valuation
For profitable businesses, future maintainable earnings valuations are the most common method of valuation. Future maintainable earnings valuations take into account future earnings vs. only paying attention to the past. If your business is on the growth path, you want to make sure you do not lose out on getting a higher asking price due to a faulty valuation method.
Your business’ future determines the value of your business today when you use the future maintainable earnings valuation method. If you don’t expect your profits to maintain stable, you can’t use this method.
If you do determine you can use the future maintainable earnings valuation method, evaluate the sales, profits, expenses, and gross profits from the last three years in business. When you have the last three year’s figures, you can predict the future and get a higher value for your business than using other methods.
4. Discounted Cash Flow Valuation
Discounted cash flow valuations are used when you aren’t sure if profits will remain stable in the future. Take your business’ future net cash flows and discount them to present day values. When you use these figures, you know the discounted cash flow valuation of your business. These figures tell you how much money your business assets are likely to make in the future.
The purpose of using DCF is to estimate the money an investor receives from an investment with an adjustment for the time value of money. Time value of money assumes that today’s dollar is worth more than a dollar of tomorrow. Since a dollar from the future isn’t worth as much as a dollar today, DCF is an important factor to look at when investing or selling a business.
Which Method Should You Use and When?
Depending on why you need your business valuation, you may need to use a different method. Business owners that want to know their solid numbers for today don’t necessarily need to use valuation methods that predict the future. On the other hand, business owners that want to sell their business for the top price will not get the results they want if they fail to calculate future numbers.
In most cases such as courting potential investors, getting a business loan or selling your business, you want to have a full business valuation done by a professional company. If you fail to look at all the angles of your business, you are leaving money on the table.
When you have professionals take care of your business valuation, they know what method is the best to use to get the results you need. Your area of brilliance is operating and growing your business, and if you take too much time away from doing important daily activities, your business could suffer. Instead of harming your business potentially, let someone else take care of these things so your business can continue to flourish.
When you receive a business valuation from a professional company, you get a certificate. You can show this certificate to potential buyers, loan officers, potential investors or anyone else that needs to know the value of your business. Having a tangible certificate instead of a proud business owner’s projection for their business carries much more weight.
If you are selling your business, you need to start working on your business valuation right away. Many companies start the process years before deciding to put their business on the market.
Choose the Right Valuations for Your Needs
Even after you understand business valuation and these top methods for valuing a business, it can seem confusing. The best plan of action is working with professionals to come to the true value of your business. When you work with professionals that understand business, you will be able to get the best price for your business.
