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Understanding Business Valuation: How to estimate what your business is worth

Business Valuation concept image
By Carrie Zhou Director, Valuation Services, HA&W

As a CEO or business owner, you may be seeking to sell or recapitalize your company at some point. Before you get there, you need a working understanding of the value of your business. You also need to know what your business is worth for audit compliance, tax purposes or legal disputes. In transactions, such as mergers, acquisitions and recapitalization, you want to maximize wealth as a seller. As a buyer, you want to increase ROI. Either way, you want to reduce the time, expense and energy you invest to get the most out of a transaction.

Before you list your business, you should know there are three common approaches you can use in estimating the value of your business:

  1. The asset-based approach determines value by adding the sum of the assets of the business minus business liabilities to arrive at the net asset value. This often delivers the lowest value for your company.
  1. The income approach determines value by calculating the net present value of the benefit stream generated by the business, or discounted cash flow. In other words, the value of your business is based on the expected economic benefit and level of risk associated with the investment.
  1. The market approach determines value by comparing the subject company to other companies of the same size, in the same industry and/or within the same region. Similar to comparable sales are used in real estate appraisal, the supply and demand forces would drive the price of your business in the free market.

Under these three approaches, you can build a variety of models using different methods to calculate the value of your business. Each approach comes with different advantages and drawbacks. So you must consider a number of variables when applying these techniques to figure out which approach is best for your particular company.

It is a good idea to work with an objective, experienced professional to help you determine the value of your business, partial interests and intangible assets. And here are some key terms you will want to become familiar with:

  • Industry: Valuation can be based your industry and comparing similar businesses.
  • NAICS Code: North American Industry Classification System used to measure economic activity.
  • Business Operations: Detailed description of your operational procedures.
  • Total Sales: Valued at a multiple (depending on your industry) of your annual revenues.
  • EBITDA: Earnings Before Income, Taxes, Depreciation and Amortization to measure performance.
  • COGS: Cost Of Goods Sold to determine carrying value of goods sold during a particular period.
  • Assets/Liabilities: List of all your tangible or intangible economic resources (assets) and the future sacrifices of economic benefits you are obliged to make to other entities (liabilities).
  • Inventory: Specifically, the cost of unsold goods (inventory) at the end of an accounting period.
  • Number of Employees: To classify your company size in the US, you can consider less than 250 employees a small business, less than 500 a mid-size business and less than 1,000 a large business.

Want to get a baseline estimate of the value of your business?  Click Here to Take the Business Valuation Assessment.

This online assessment takes about 45 minutes, including a custom report and a telephone consultation with a CEO Tools designated business valuation consultant.