How to Value a Business

Learn all about the different valuation methods here

How to Value a Business

What intangible factors might affect the value of a business?

Sometimes, the value of a business cannot be measured by simply looking at the figures. Some factors cannot be easily measured, but will nevertheless affect the value of a business, including:

  • Relationships with suppliers or customers. If a business has a key customer who has committed to staying loyal to the company, or exclusive distribution rights from a supplier, this will push up the value of the business.
  • The value of key people. Especially in consultancy-type business, a lot of the business’ value will lie with employees who have particular expertise or strong relationships with clients. From a purchaser’s point of view, this can also introduce risk into the equation – what happens if you buy the business and one of the key creative people leaves?
  • The market. How the market is going generally will have a huge effect on the real value of a business. For example, a dial-up internet business in 2000 might have had a high asset valuation, but its real value would have been much lower as the broadband sector began to gather momentum.
  • Risk and uncertainty. More generally, a high level of uncertainty will reduce the value of a business. You should remove the sources of uncertainty and risk – learn how to do so here.

How can I value a business?

There are several different ways to value a business, and which method you choose will affect the final figure you come up with. The main valuation techniques are:

  • Asset valuations
  • Price/earnings ratio (P/E ratio)
  • Discounted cashflow
  • Industry rules of thumb
  • ‘Entry cost’ valuations

For information on each technique click the index links.

Asset valuations

You should use asset valuations if you have a stable business with lots of tangible assets, like a property business or vehicle dealership.

Essentially, asset valuations follow a simple formula:

  • Add up the value of all your assets
  • Subtract your liabilities
  • Arrive at a valuation

Your starting point will be the value of the assets in the business’ books, known as the net book value (NBV). This is not the end of the story, however; the valuation must be tweaked to reflect the true value of the business, by taking into account factors including:

  • Depreciation in the value of assets
  • Bad debts
  • Unwanted stock, which will have to be sold off for less

If you are looking to value a business which has or is about to cease trading, various other factors will affect its worth, including:

  • Assets being sold off quickly (and therefore cheaply) to satisfy creditors
  • Potential redundancy payments
  • The cost of winding up the business

Price/earnings ratio (P/E ratio)

This is the most common method for determining the value of public companies. If the business you wish to value is quoted and turning a stable profit, using the P/E ratio will normally result in an attractive valuation. Companies that aren’t publicly listed will normally have much lower P/E ratios, so it’s not an ideal method in this scenario.

The formula for calculating a business’ P/E ratio is:

  • Work out the market value per share
  • Divide this by the earnings per share
  • Arrive at the P/E ratio

The EPS is calculated by taking a company’s net income over the last four quarters, subtracting dividends, then dividing the rest by the number of shares outstanding.

We can use an example to illustrate how this works. Say a company is currently trading shares at $30 per share, with an EPS of $.0.40 per share. Divide $30 by $0.40 to arrive at the P/E ratio. So in this case, the company would have a P/E ratio of 75.

Of course, a P/E ratio of 75 doesn’t tell us very much on its own. P/E valuations are essentially comparative, so you determine the worth of a company by looking at other companies’ P/E ratios in the same industry. You can normally find these, for larger companies at least, using a simple web search.

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