The fundamental truth is that your business is only worth as much as people are willing to pay for it. One person may have a better understanding of the risks involved, while another may simply fall in love with the place.
That’s not to say there’s no value in valuations. Knowing what your business is worth will give you the confidence to ask for a realistic and fair price for your business.
Businesses are often divided into three parts when they’re valued – tangible assets (such as premises, machinery and vehicles), stock (such as materials and supplies) and intangible assets (such as exclusive contracts and patents or goodwill).
Your intangible assets are the elements of your business you’ve developed over the years that have increased the business’s potential for success, such as a great word-of-mouth reputation with the target market or a sought after brand.
However, sometimes a business is all about its tangible assets. In this situation, the business as a whole can simply be valued for its assets minus debt. This figure is known as the asset valuation.
Alternatively, the assets can just be bought on their own, in which case they are valued on whether they could together enable another business to go into operation. If the answer to that question is yes, the asset value should be much higher than if they were sold individually as salvaged items from a business that has closed down.
A cost of entry comparison simply sets a lower limit on the value of a business on the basis of what it would cost the buyer to start a comparative business from scratch and get it to the same point.
It’s widely used as a valuation method because it takes account of both tangible and intangible assets. So, if you estimate the buyer would probably have to spend $200,000 to get set up and then pay $15,000 in overheads each month for two years before they get the business to the stage your one is at, then you can say your business is at least worth $560,000 to them.
Of course, the buyer will probably present their own cost of entry comparison using the cheapest possible options, in which case you have to find a realistic middle ground.
The price–earnings ratio or P/E ratio multiplies a business’s net profit to arrive at a value that focuses solely on its potential for future earnings.
One industry’s P/E ratio could be quite low – reflecting a lower potential for earnings – while another’s could be quite high. Some large Internet-based businesses, for example, have been known to sell at 10–15+ multiples of their last annual pre-tax profit.
P/E ratio examples for publicly floated companies can be found in the financial section of newspapers, but to find an accurate P/E ratio for your business and industry you need to consult relevant business groups such as your industry association.
When valuing a business, you should always consult a professional and seek the advice of your accountant or lawyer.
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