Knowing how much your firm is worth at any one time can be quite helpful in determining how to offer more value or become more efficient. We look at the various methods for determining the worth of your firm, as well as why it is necessary in the first place.

Why should you know how much your business is worth?

Valuing a firm is typically necessary for obtaining funds and loans or negotiating its sale price, but there are other reasons.

For example, if you intend to issue new shares to raise capital for your firm, assessing the company’s value will help you obtain a reasonable price. Perhaps you need to modernize your equipment or facilities and want to utilize some or all of the company’s assets as collateral when applying for financing.

Frequent valuations can also help evaluate how effectively your organization is achieving its goals. In addition to assessing overall value, you may analyze how each component of the firm contributes to it, which may indicate areas that require improvement.

Check out: How do I make responsible business decisions?

What distinguishes valuation from price?

The value of a firm is not always the price you can expect to obtain if you sell. Similar to buying a house or a car, the publicized amount is frequently used as the starting point for subsequent discussions.

Whether you’re selling or looking for financing, the ‘price’ depends on what someone is willing to pay and can be influenced by a variety of other circumstances. For instance:

• Do you need to sell quickly, or are you being pushed to sell?
• Are there any planned changes to legislation that will affect you?
• Is there a new competition in the market?

Valuing your business

Since every company is distinct, the valuation process can be seen as an art, with no universal ‘right’ approach to it. Owners and brokers typically utilize various approaches to help them see the big picture.

Your bookkeeping data will frequently serve as the foundation for any technique, feeding into your reporting to show your company’s financial health over time and assisting in making future predictions.

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Resources

Most firms have assets in some shape or form, and these can assist determine their value.

• Tangible assets that the business owns, such as equipment or property, are a good place to start because their worth is usually easy to determine.
• Intangible assets, which have value but do not have a physical form, include brand authority, customer relationships, trademarks, and Intellectual Property (IP).

These affect the value of a business because they have an impact on its potential to generate revenue, which is what the buyer is most interested in.

Your accounting will reflect the net value of your business assets (at least the tangible ones), but you must also account for asset depreciation and other obligations. This is why proper asset management is so important.

The importance of goodwill

In business words, ‘goodwill’ refers to your brand’s value in the marketplace, which has grown over time and is recognized by customers as a sign of excellence. It can be extremely valuable but hard to define!

Price-to-earnings ratio

The price/earnings approach (also known as the profit multiple) is best suited to organizations having a strong track record of good profitability. It works by:

• Adjusting monthly or yearly profits to exclude any extraordinary events (such as one-time significant costs or purchases) will give you a better indication of what future profits might look like.
• Adding any additional expenditures or gains incurred by the company after additional investment or sale. This will result in a final profit figure known as “normalized profit”.
• Multiplying conventional industrial practice by normalized profit (often 3 to 5).

The resulting figure will be your price-earnings ratio, which will provide you with an estimate of value.

Comparable

This is a tried-and-true way of appraising a firm in the UK. It essentially entails looking at what similar businesses have sold for in recent years and calculating a value for your own business appropriately.

It’s similar to when you sell your house. Before deciding on an asking price, you research what others of a comparable size and specification have sold for in your neighborhood.

Cash flows at a discount

Discounted cash flow is a standard method for valuing a substantially invested organization with a lengthy history and predictable, stable cash flow. It can be rather complex, however, and is primarily based on future assumptions that are not always easy to foresee!

The valuation is determined by forecasting the company’s total dividends for the upcoming 15 years, along with a terminal value that will be assigned once this period concludes.

A discount interest rate is used to calculate the current value of future dividends (which typically ranges from 15% to 25%). This takes into account both risk and the time value of money (the idea that £1 received today is worth more than an identical amount received later).

Entry-cost appraisal

This occurs when the valuation is determined by assessing the expenses involved in building a comparable business from the ground up.

It takes into account all of the expenses that would be incurred, such as HR and labor costs, stock purchases, training, client acquisition, and asset purchase or leasing. Everything, basically!

Industry norms of thumb

Almost every industry has its own standard method of valuing enterprises within it. Retail businesses, for example, are typically valued based on a multiple of turnover, number of locations, or number of consumers.

However, in a separate industry, such as computer repair, the value is frequently determined only by turnover. Estate agencies will be classified based on the number of branches they have, among other factors.

How do investors in venture capital assess businesses?

How do investors in venture capital assess businesses? Professional investors, particularly venture capitalists, adopt a markedly different method for assessing business value. While they take into account profits, assets, and similar companies, they align this with their exit valuation rather than focusing on their entry valuation.

They consider the rate of growth and apply an exit multiple from reasonably comparable companies plus a predetermined rate of return. This allows them to determine how much money they are willing to offer.

Keep in mind that selling a high-growth business to a venture capitalist can be much more (or much less) profitable than selling to another company or individual.

If you are looking for an accountant to help you with your queries related to your business accounts, Call at 020 35765107 or send a message to book a free consultation. Learn more about our online accounting services and pricing.

Note: It must be noted that the information provided in all our blogs are solely for the awareness purposes and are designed with the intention to create an ease for the reader to understand the rules and their importance. However, it should never be considered as an ultimate replication of rules. RezEx Accountants (RezEx Ltd) does not own any responsibility for any unpleasant event that may arise due to misinterpretation of a specific part or whole of the information.