How much can I sell my business for? Methods of business valuation

There is no single way to value a business. However, if you are considering the sale of your company, it is likely that you will want to know how much you can expect to achieve from the sale – both for planning and marketing purposes.

Thankfully, most sellers tend to use one of four main methods as the best way of valuing their company, through assessing: price-to-earnings ratio, asset valuations, entry cost, and discounted cash flow. Below, we’ve explored each of these methods, in turn, providing an insight into the businesses that may suit each option, as well as an example of calculations for each.

However, before you get started, it is important to consider the assets and other factors that could influence your calculations, some of which could heavily affect the value of your business.

Business Valuation Factors

No matter what valuation method you choose, you will have to consider one or more of your business’ assets and factors.

There are many different factors that should be taken into account when valuing your business, including tangible assets (such as machinery) and intangible assets that are harder to quantify (reputation, for example).

As companies are so varied in terms of what they offer and how they are run, it is possible that not all of these factors will apply to you but check carefully before you begin your valuation process to ensure none of your assets are overlooked.

Assets you should consider:

Buildings and structures

Machinery and equipment

Stock

Land

Reputation (including social media following)

Client value and track record

Trademarks and intellectual property

Track record and time in business

Type of product or service

Number and quality of employees

Methods of Valuation

Price-to-earnings ratio

The method of valuing a business by price-to-earnings (P/E ratio) is arguably the most common. It is considered the best choice for a business demonstrating strong profits as it can indicate both high forecasted growth and a track record of repeat business.

Methods for achieving the right P/E number vary and the numbers themselves often range between four and ten. Typically, though, the figure is calculated by measuring the company’s current share price relative to its per-share earnings (EPS).

Pricing with P/E ratio

Once you’ve established your P/E ratio, putting a price on your company is simple - just multiply your post-tax profits by this ratio.

For example, if your business has post-tax profits of £500,000 and a P/E ratio of four, you would price it at £2 million. If your business has post-tax profits of £1 million and has a P/E ratio of five, you would value it at £5 million.

Asset valuation

Asset valuation is often the method of choice for strong and stable businesses brimming with tangible assets, such as property and machinery.

In order to calculate value accurately, you should begin by working out your company’s Net Book Value, which comprises of the assets that are included in the company’s accounts. However, you should also factor in any economic influences that govern these assets, such as a drop in value over time or a rise due to increased demand.

While asset valuation can often result in the lowest value for a business – failing to take into account the company’s reputation or the strength of the business – it can be beneficial for asset-strong businesses and can also be used as a ‘cold asset value’ to act as a basis for a market valuation.

Pricing with asset valuation

Pricing with asset valuation is fairly straightforward. Simply calculate your Net Book Value, remove any lost value, and price based on your final figure.

For example, if your total assets give you a Net Book Value of £2 million, but the age of your machinery means that particular asset has dropped in value from £400,000 to £200,000, you would remove the loss from your total and achieve a final valuation figure of £1.8 million.

Entry cost

The concept of entry cost is just as it appears – the cost of creating your business from scratch should you start again.

As with all valuations, it’s important to remember which of your assets and other factors need to be considered to ensure you don’t undersell your company. This can include tangible assets – property, machinery, equipment upgrades – and other start-up costs including design, development, recruitment, training, and marketing.

Pricing with entry cost

Pricing your business using entry cost valuation is relatively simple, as long as you ensure you take into account all factors that would need to be considered should you set up the business from scratch.

This is a very individual process and will require you to consider everything you have purchased or invested in to get you to this point. However, you should also take into account any savings that could have been made, as a result of picking a different location, using new services or now-available modern technology that can push down your costs. Then simply remove these savings from your entry cost to establish a good price for your company.

Discounted cash flow

Discounted cash flow is a complicated valuation method that is almost exclusively used by large, established businesses such as energy companies that are likely to be able to predict cash flow.

This method requires you to estimate what your future cash flow might be worth today, plus dividends forecast for the foreseeable future and residual value for the end of the period. Use a discounted rate to calculate today’s value of each future cash flow, which ensures you take into account risk and the money’s real-time value. This discounted rate can vary between 15 and 25 per cent. Put simply, this option is based on the cash flow that will be available to new owners.

The main issue with this method is establishing the cash flows that should be discounted, particularly in the case of complex investments. However, it’s also a difficult method to use if you’re unable to access future cash flows.

Pricing with discounted cash flow
Unfortunately, calculating the amount your business is worth using discounted cash flow is relatively complicated. However, there is an equation you can use to make the process simpler. This is as follows:



In this equation:
CF = cash flow (the cash payments an investor receives)
r = discounted rate (typically your Weighted Average Cost of Capital or WACC)
n = period/year number (typically five years)

Read a more detailed explanation of the DCF method of valuing a business.

Ultimately the price at which you can sell your business is dependent entirely on how much it is worth in the first place, and the various company valuation methods can assist with putting a price on the business as a whole. If your business is your brainchild, built over years with much time and effort invested, it is likely that you will have an emotional connection on which you cannot tag a price; however, to achieve the best possible price exempt of emotional ties, a price-to-earnings ratio, asset valuations, entry cost, or discounted cash flow valuation method will help you determine a well-grounded and respectable sales figure.

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MUST READ: Are you really ready to sell your business? If you are interested in learning more about preparing your company for exit even if you have no plans to sell, read our in-depth article on Why you should boost your business's value regardless of whether you plan to sell.

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