Have you ever wondered what your business is worth? Perhaps you have heard some rules of thumb like a business is worth three times gross profit or two times sales. These methods are very circumstantial and can vary across industries and regions. However, whereas valuing a business is never an exact science, there are some methods you can use that will give you a rough idea.
The two main ways to estimate the value of your business right now are the asset-based method and the cash flow method.
The asset-based method is simple.
Business value = Total assets at their current value – (assets’ selling cost + liabilities)
A non-exhaustive list of assets can include any cash, furniture, inventory, prepaid expenses and accounts receivable.
The asset-based method is most accurate when your business is just getting started or is no longer able to operate and not a ‘going concern’. It gives you the amount the business would be worth by just selling off its assets.
If your business is a ‘going concern’, you may get a more accurate result by using the cash flow method. This method is slightly more complicated, but simply put is predicting future earnings based on past cash flows and then using a multiplier to give you a value for your business.
The first step is to look at the last few years of income statements and decide which most accurately forecast future earnings. Then you must take the net income and convert it to expected cash flow. This step requires you to add back to the net income certain items such as income tax, depreciation and any revenue or expenses that will be different in the future.
Then you need to multiply the expected cash flow by a multiplier. This multiplier is equal to the inverse of the rate of return (1/ROR). For example, if you expect a ROR of 20% on your business then your multiplier is 5. The result of this multiplication is an estimate of the value of your business.
Business value = expected cash flow x multiplier
If you are considering selling your business, one great place to start is with The Ask by Liisa Atva. This book not only walks you through the two methods I mentioned above, but gives you tips for selling your business – who to contact, what you can do to increase its value. I found it particularly valuable because the author is a Canadian Chartered Professional Accountant and the book has information relevant to a Canadian audience.
Knowing the value of your business is a useful exercise to perform from time to time. Give one of the above methods a try or consult business valuation professional.