Selling or buying a small business comes with a plethora of responsibilities that you need to fulfil. However, one of the top priorities in any of the two cases should be valuing the business accurately. There are a lot more reasons why you may consider a business valuation.
Valuing a business can bring many advantages, like attracting investors and obtaining business financing. The market value of a small business is affected by so many factors, which is why people often prefer taking the help of a professional. Such professionals are well-versed in corporate management or corporate financing, investment banking and financial markets.
Business Valuation- What Is It?
A business valuation, otherwise called company valuation, is the process that determines the economic value of a business. All the areas of a business are thoroughly analysed in the valuation process to determine the actual worth of the business and its units and departments.
A business valuation is useful in determining a business’s fair value for multiple reasons, like sale value, taxation, establishing partner ownership and even divorce proceedings. Oftentimes, owners turn to professional business evaluators when it comes to an objective estimate of a business’s value.
Why you might need a business valuation?
There are a range of circumstances when business valuation is required. The following are the reasons for which you may need business valuation:
- Changes in ownership or capital structure
- Buying and selling a business
- CGT Or Capital Gains Tax rollovers
- Entry to, exit form or formation of a consolidated group
- Company divestments/acquisitions
- Succession planning
- Insurance and risk management
- Thin capitalisation
- Divorce or division of assets and liabilities
If you wish to accurately value your business, you will need to provide information about the following to your accounting professionals:
- finances and assets;
- business profile;
- legal information;
- procedures and plans;
- and customer information.
Multiple valuation methods can be used with the hopes of combining several valuation methods to get the final value.
Factors that need to be considered when valuing a business
Certain factors have to be considered when valuing a business for sale in Australia that have a significant contribution to its market price.
The first factor that can affect the value of a business is business assets. Intangible assets and tangible assets have a great impact on the value. Assets like property, tools, equipment, machinery and inventory are the tangible assets of a business.
Intangible assets, on the other hand, include the goodwill of the company, customer loyalty, intellectual property such as trademarks and patents, a huge client database, being a well-respected brand and strong growth potential.
Businesses that are financially healthy or have a strong financial position will have a high chance of using for more favourable sales terms. As a result, their business value may also be higher compared to others.
So it is better to ensure that you have the financial statements for a couple of years ready, as well as debt records, cash flow forecasts, P&L statements and annual turnover.
Years of operation
Generally, a business that has been operating for quite some time already has a clear track record of performance when it comes to sales, customer acquisition, and overall financial growth.
Such a business already has a considerable loyal customer base and key business relationships for referrals. New businesses, on the other hand, that are doing well currently may have a hard time demonstrating longevity in financial performance.
Besides these three factors, there is another factor that may have a huge impact on your business value. It is the reason for selling the business, especially when the valuation is taking place due to an impending sale. In case you have to sell your business quickly owing to urgent financial needs, the business value may be driven down.
Methods of valuing a small business
There are a couple of valuation methods that can be used to determine the value of a business. Since no valuation method is classified as the best one, a professional business valuer may suggest the use of a combination of valuation methods to get the best outcome.
Let us pay attention to some of the most used methods when it comes to valuing a small business.
Current market values
You can determine your business’s market value by paying attention to the industry you are in.
This method will depend heavily on the following:
- the industry;
- seasonal trends, and
- the current market value of a business similar to yours in your industry
If the future projections of the industry are good, it might be advantageous for your business.
You need to ensure that you are researching industry business sales in the relevant market. Along with this, it would be best if you also check for statistical data that has been grouped by industry with the ABS or Australian Bureau of Statistics. This will allow you to have an independent valuation of the economic conditions of the industry you are operating your business.
Return on Investment (ROI)
In this method, you can determine how to value a business through its ROI or Return on Investment. ROI valuation uses the net profit of a business to calculate its value.
You can choose to:
- Calculate the selling price based on the ROI (Return on Investment) you wish to get
- Figure out what the ROI will be if you sell the business for the price you have in mind
You can use the following formula to do the same:
ROI = (Net annual profit/Selling price) x 100
Selling price = (Net annual profit/Return on Investment) x 100
Cost of creating the business from scratch (Entry Cost Valuation)
Justifying the price you wish to sell your business for can be challenging. In such a case, calculating the cost of creating your business from scratch may help you validate the value.
You need to ensure that you are including all the costs involved in starting your business to calculate the value.
- Licence and permit fees
- Buying stocks, machinery, tools and equipment
- Fees paid to consultants, coaches and advisers
- Cost of recruiting, training and employing contractors and staff
- Cost involved in research and development of products and services
- Software subscription fees
- Cost of buying or leasing business premises
- Investment in branding, marketing and promotion
- Investment in establishing your online presence (this includes Search Engine Optimisation, social media and website)
Net worth of business assets
A business’s net worth is the difference between its assets (what it owns) and liabilities (what it owes). Here’s the formula:
Net worth = Assets – Liabilities
When calculating the net worth of a business, the following needs to be considered:
- Tangible (current) assets
- Tangible (non-current) assets
- Intangible assets
(We will discuss how you can value the assets in the later section of this blog.)
A professional may consider the following when it comes to assets:
- age, currency and relevance
- current condition
- impact or contribution on the ability of the business to perform
- replacement value versus the market value in the current state of the asset
Annual net profit
Potential investors or buyers prefer to purchase a business based on the value of its historical as well as future profits. You can use the following two to show this:
- Financial forecasts
- Financial statements
This value can be used when:
- deciding the selling price for your business
- negotiating for finance
Factors like assets, the current market value and liabilities also need to be considered when you value your business based on annual net profit.
How to value a small business’s assets
Since there are different types of assets, their methods of valuation are also different. Here is how you can value the assets of a small business.
Valuing Current Assets or Short-term Assets
In the short-term assets, accounts receivable, inventory and other ‘liquid’ assets are included. Liquid assets can be expected to be converted into cash in a year. In order to value these, the on-hand trading stock or inventory and balance sheet of a business are reviewed by a licensed business valuation specialist.
Valuing non-current Assets
Land, buildings, tools, machinery and plant, computer equipment and motor vehicles are included in long-term or permanent business assets. Usually, the valuation of these assets is done by deducting the accumulated depreciation from the actual or original acquisition cost.
An asset’s depreciated value may sometimes be different than the market value of the said asset. Thus, you have to pay attention to it.
Valuing Intangible assets
When it comes to intangible assets, patents, copyrights, goodwill, customer lists and intellectual property (IP) are included. Out of all the three kinds, valuation for intangible assets is the most difficult. Thus, reaching out to a professional is highly recommended.
How to increase the Market value of a business
If selling your small business has been on your mind for quite some time, you may wish to improve the market value in advance. So, here are three ways in which you can do the same:
Short leases, declining net profit, and poorly maintained premises are some of the features of risky businesses, among other features. Mitigating these risks adds value to a business on paper and, as a result, makes it more appealing to buyers.
Improving the bottom line
Optimising the wage cost percentages and the gross profit percentages can help a business owner improve the financials of the business. You can consult a business accountant, who can help you understand the current numbers and also help you find the most suitable way to achieve this.
Growing the business
In order to exponentially grow the customer base of your business, active advertising through wide-reaching mediums like social media can be extremely beneficial. Since having a ‘dry’ social media page may indicate that the business is falling, you must have an active social media strategy would be a great investment if you wish to sell your business.
Business valuation is not always a priority for a lot of businesses. However, it is not a task that can be put off until it is time to sell the business.
With a clear idea of the value of your business, you can deal with other critical business matters, including financing, getting more investors and session planning.
Disclaimer: The information on this website is for general purposes only and should not be relied upon for making legal or other decisions. The advice provided in this article is general in nature and is not subject to the personal financial situation and needs of any individual. Clear Tax tries to keep the information accurate and up-to-date; however, you should bear in mind with changing circumstances, the accuracy and reliability of the information will not necessarily remain the same. The information is by no means a substitute for financial advice.