What Valuation Is and Isn't...
Valuation Standards
Please read
our disclaimer
and privacy policy
Valuation Methods
What follows are the four Valuation methods that are most likely to be used to value your business. Which of these methods used depends on the nature and size of your business. As you may have read on other pages of this site, Valuation is just as much an art form as it is a science, and experience more than anything tends to make our decisions (such as this one) for us.
Method 1: Asset Valuation
Method 2: Capitalised Future Earnings
Method 3: Earnings Multiple
Method 4: Comparable Sales
Method 1: Asset Valuation.
This method focuses on the assets net of the liabilities, and though not taking into account the goodwill for the business, this method may be, in many cases, the most appropriate for under performing businesses. The basic premise is as follows.
Of course it isn't as simple as that, but that's the idea. Take the following example-
Example
Steve wants to by a cafe business. the business balance sheet may look something like this.
Once again, this method does not take goodwill into account. In most cases however, goodwill (i.e. service, location, reputation etc) is a major factor in the business, and as such would have to be added to the net assets to achieve an accurate valuation.
Method 2: Capitalised Future Earnings.
Buying a business also means buying the rights to any future profits that the business may accumulate. The value of these profits, in many cases, far out way any assets and as such this method serves to capture that value. For most small businesses, Capitalised Future Earnings is the valuation method of choice and focuses on Adjusted Profits and Return On Investment as its basis.
Before looking at this method, we should clarify the basis for which a Return Of Investment is calculated. The Return on Investment (ROI) relies on the level of risk associated with a business, and assumes that the lower the risk, the lower the ROI, and resultantly the greater the value of the business.
Characteristics of a ‘low risk’ investment with an ROI of approx 25% may include-
- Established over 10 years having a good track record and stability.
- All books and records in order.
- Sufficient number of employees to ensure uninterrupted operations if more than 20% of the work force is absent for a short or prolonged period of time.
- Sufficient number of customers to ensure that any one customer does not represent more than 10% of the business revenue.
- Established market position that provides relative protection against competition.
- All or most of the customers on long term contracts.
- Most processes and operations with operation manuals and systems in place.
- No reliance on one or a small number of employees.
- No reliance on the owner for the day-to-day management of the business.
- No excessive specialized knowledge required by the owner of the business.
- Adequate, favorable and without uncertainties, length of lease and conditions.
- Easy staff replacement relative to the business and staff position.
- Increasing profit trends.
- Clearly defined opportunities and plans for future growth.
- Non-declining business industry.
- Sales systems and infrastructure in place that will ensure a sufficient amount of new business to sustain the same level or increased level of sales in the future.
Example
Paul wants to sell his manufacturing business. He currently manages, but the assumption is that a new manager will be installed when the business is sold. The following table serves to calculate his Adjusted Profits.
Pauls Business is relatively low risk, and as such his ROI is set at 28%. The resultant Capitalised Future Earnings equation would look like this-
Method 3: Earnings Multiple.
The simplicity of this method is that it relies on knowledge of similar sales of businesses.
To put it simply, you multiply the business’ earnings before interest and tax by a selected number. The selected number depends on the industry and growth potential of the business. For example, a café established for less than 2 years might be valued at as little as 1 years earnings, whereas an established manufacturing company could sell for as much as 5 times the yearly profits. Again this method comes down the risk involved in the investment, and is based on similar sales of businesses to help determine the earnings multiple.
Method 4: Comparable Sales
This method relies solely on the recent sales of similar businesses. Whichever Valuation method used, information of comparable sales is usually taken into account.
When it comes down it, chances are, the Valuation you receive will involve elements of all of the above methods and resultantly, be more likely to extract the true value of the business.
To find out more about our methods, or to arrange a meeting CALL NOW, or leave your details on the form bellow and we’ll call back as soon as possible. A consultation could mean the difference of tens of thousands of dollars in your pocket.
| Telephone: | 1800 VALUE1 (1800 825 831) |
| Telephone: | 9817 3331 |
| After Hours/Weekends: | 0410 654 114 |