How to determine your SME's value
Wondering how to value your business but not sure how to go about it? Valuating your company can be beneficial to your growth. It can help you understand how to better your businesses' financial situation too.
This helpful guide from Bionic will clear up any confusion and teach you how and when to value your business.
What is a business valuation?
A business valuation is a way of estimating how much money your business is worth. Most business owners carry out a valuation to understand how to increase the worth of their SME, usually before putting it up for sale.
If you’ve put lots of effort into making your business a success, it’s rewarding to see that pay off if you find your company is worth more than you thought. On the other hand, if your business isn’t as valuable as you expected, it gives you room to make improvements in the future.
Ideally, as a business owner, you want to see a valuation figure that doesn’t sell the business and its assets short. However, the valuation also shouldn’t overstate what the business is worth.
Why value a business?
There are many reasons why business owners choose to have their SME valued. Some of them include:
- To help buy or sell a business- Potential buyers will want to know what kind of financial situation your SME is in before they make an offer or express serious interest.
- To create an internal market for shares- Your staff may be interested in buying shares in the company but might want to see how much it is worth first.
- To raise equity capital for shares- You might want to see how much your business is worth for security purposes.
How do I get a business valuation?
Arranging your first business valuation can be daunting. But it's not as hard as it seems. There are a few things to consider but once you’ve wrapped your head around the different ways you can value your business, you should be well on your way to understanding your company’s worth.
These are the main ways to value your business:
1. Asset valuation
Asset valuation is simply checking how much your business assets are worth. When speaking about ‘assets’, there are two different types in business: tangible and intangible.
- Tangible assets are the physical things belonging to your business, such as your premises, stock, land, and equipment.
- Intangible assets are any non-physical additions to your business. These can be things like your brand, reputation, intellectual and copyright.
To get the value of your business via asset valuation, all you need to do is add the worth of your tangible and intangible assets together. Then subtract any business liabilities - things like debt and any owed credit - and you’ll end up with a good estimate of your company's worth.
As a general tip, make sure you keep a record and regularly update information on your assets. Their value may change due to things like inflation so it’s good to keep an eye on what your business owns and its worth.
2. Discounted cash flow
The discounted cash flow method is a way to value your business based on income.
It’s usually used by bigger businesses that have predictable cash flow but if this method appeals to you then try it out.
All you need to do is apply a discount interest rate (this will usually be between 15% to 25%) to cover risks like unexpected bills or things going wrong, and the time value of money.
When we talk about ‘the time value of money’, we mean the idea that £1 earned today will be worth more than the same amount made tomorrow due to earning potential.
To get your estimated business valuation, simply add your projected takings forecast for the next 15 years and add a residual value. If your estimated business valuation is higher than today's number, then your business is likely a good investment.
To find out your company’s growth rate, just compare your previous year’s cash flow with earlier years. For example, if your business cash flow was $25 million in 2020, compare that number to the cash flow in 2019 and see how much it grew.
3. Industry practice
Businesses in different industries are worth different amounts and some sectors buy and sell companies more than others.
It's best to do some research into your own industry before valuing your business. Then you can see how similar businesses assess their own worth. Your own sector might have some specific rules or useful tips to share. For example, the retail industry works a little differently, businesses are valued on business turnover, how many customers it has, and any outlets it may have.
4. Entry valuation
Evaluation means working out how much your business is worth based on if you were to start from nothing.
The vital question asked in an entry valuation is: ‘if my business didn’t exist, how much would it cost to start it up this minute?’
You can estimate your company’s value this way by creating a list of things you’d need if you were creating your business from scratch.
Once you have this list written up, consider how you could save as much money as possible when setting up.
After working out all your potential savings, all you need to do is subtract these savings from your start-up costs. Then you’ve successfully worked out the value of your business based on entry valuation.
For example, if you worked out it would cost £6,000 to set up your business from scratch, then subtracted £1,000 in realistic savings you could make, you've then worked out your business is valuated at £5,000.
5. Comparable analysis
A comparable analysis is a quick and simple way to value your business. Simply research a business similar to yours that has recently been sold and assess your own worth using the other company as a guide.
How can a valuation help my business?
A business valuation can really help you understand your financial situation. If you know how well your business is performing and how much it’s worth, you’ll be able to make better financial decisions in the future.
Plus, a valuation will help bring to light any improvements you need to make to allow your company to shine.
A business valuation can also help when:
- You’re trying to secure an investment – If you’re planning to invest, many investors want to see an actual figure representing the company’s worth before they consider putting money in. Find out more at our guide to finding the right investor for your business.
- Planning to expand your business – If you’re looking to expand, an annual valuation might help you secure funding for planned works.
- Setting a price for employee shareholders– If your employees want to buy and sell shares in the company, they’ll likely want to know how much it’s worth.
- Arranging a business partnership: Most potential partners want to see how well a business is doing before they part with any money.
- Filing taxes – If you’re filling in a company tax return, you might need a valuation number to give them.
Does anything affect a business valuation?
There are some parts of a business you can value easily, like tangible assets, your premises and stock. But, intangible assets can be a little harder to value. When determining how much your intangible assets are worth, you should look at:
- How valuable your customers are to the business- If you have loyal customers who love your brand, it’s easier for a new buyer to continue those relationships rather than start attracting customers from scratch.
- The reputation you have built up as a business- If your business has good connections with suppliers, employers, and customers it makes a real difference. A business is less risky if it has a positive reputation as the groundwork is already there.
- Any trademarks you have as a business- Trademarks can be real assets as they demonstrate your business is recognisable and has its own branding.
- The circumstances surrounding the valuation - A business having a forced valuation because of money issues — such as a forced sale due to debt — is more of a risk to take on than an SME in a good financial position.
- The strength of the team behind the business- A great team can really propel a business forward to success, if there is a lot of staff support, this acts in favour when a potential buyer is looking into your SME.
- The age of your business- An older, more established business is usually considered less risky to take on compared to a younger business with new customer and staff relationships. If your business is a startup, this has to be considered by any potential buyers. Statistics show as many as 90% of startups fold within 10 years.
- The products you sell or the services you offer- If potential buyers believe in your business and the products you sell, they are more likely to be passionate about making the business work long-term. This is why it helps to try and market your business to the right buyer.
Why should I value my business?
As we mentioned earlier, valuing your business can help give you a detailed view of how your business is performing financially. If you’re clued up about how well your company is doing, it helps you make better money decisions in the future.
Valuation helps you make decisions about:
- Whether to sell a business
- How to create an internal market for shares
- How to raise equity capital for shares
How much is my business worth?
You never want to sell your business for less than it’s worth, but you want to avoid trying to sell it for more than it’s worth too.
Trying to price up your company can be a balancing act, but valuing a business can help you focus on areas for improvement. There are lots of things you can do to help get the most out of your valuation, these include:
- Planning ahead - It’s important to have a proper business plan and know your goals for the future.
- Get advice - Sometimes valuing your business can seem like a huge task, but there is help if you’re feeling overwhelmed. Search for a qualified accountant and they can get you off to a great start.
- Think about your processes - Have a real think about how you store company information like financial records. Also, take a minute to consider how your business works and what its strengths and weaknesses are.
- Negotiate - Tangible assets are straightforward to measure, but it’s your own responsibility to promote intangible assets to potential buyers. A good customer base and a catchy brand can be invaluable and worth a lot more than you think.
- Make sure finances are in order - Before you start looking into having your business valued, make sure your finances are in good condition. Be sure to have important documents like profit and loss statements, tax returns, records of purchases, licenses, deeds and any premises correspondence kept together.
- Reducing risk - Calculate risks and try to minimise them as much as possible. For example, if you only use one specific supplier, try branching out to avoid putting all your eggs in one basket. Then you’re protected should there be a supplier problem with your stock. It’s important to periodically take stock of your business and its unique needs. Valuating a business can help do this and focus your mind on where it’s heading. You can learn a lot to prepare for financial decisions in the future, but what works for some companies might not work for your business. So do your research and adapt to your own needs.