If you have your own business, the time may come when you need to determine how much it is worth. This is a more complicated question that you might expect. First of all, the reasons for wanting to determine the company’s worth has a big impact on final small business valuations. Many first time business owners are surprised when they find out that the subjective nature of a small business valuation. Regardless of the reason you need to perform the business valuation, it is always, at its heart, a financial exercise. When you ask yourself, “How do I start calculating the worth of my business?” the first thing you need to do is decide why you want to do this and then you need to assemble your financial information.
There are three common approaches that most people use when they are trying to determine how much a business is worth.
The asset approach considers a business to be basically worth the sum of its parts. Basically you take all of your assets and add them up. Take all of your debts or expenses and add them up. Subtract the debts and expenses from the assets and you have the general valuation of the business. This is the most predictable of the small business valuation methods but does not provide a whole picture for many businesses. There are many intangibles involved in running a business and determining its worth. The time when the asset approach to business valuation may be if you are divorcing your spouse and you need to quickly determine the value of a business. If you are considering this approach, you really should start by asking yourself, “Why am I calculating the worth of my business?”
The income approach looks at your revenue stream as it is now and where it will go. This is considered to be the most technical approach of the three. What you need to calculate is the “Earnings Before Interest, Depreciation and Amortization” (ERIBA). In these businesses try to calculate what they will make in the future. This is often the way stock analysts will evaluate companies when they go public.
The last method is the market approach. Basically, you look at businesses that are similar to yours and see how much they are worth. It is great when you find a company that is in your industry and is about your size that has been sold. You can extrapolate from this what your business is worth. Economic experts consider this to be the most subjective of the three approaches. Like the other approaches, it does not take all factors into consideration. If someone compared Apple to Microsoft when they both were young and did not include a comparison of Bill Gates and Steve Jobs it would not have been complete.
What approach should I use when calculating the worth of my business?
If you are not sure which approach you should take, some experts recommend conducting all three. They suggest business owners then evaluate the results of each and go with the one that meets their needs at the time. Again, a lot of this comes down to the reason for conducting this kind of analysis to begin with. If you are pitching investors, knowing how much you are going to bring in may be an important part of your proposal. If you are just looking to sell, another approach such as the asset approach may be what you are looking for.
Small business valuations are more like art than science. When you are just thinking the question, “Why am I calculating the worth of my business?” you have to keep that in mind. Entrepreneurs often see their business’s value through the prism of what they want for it and how much potential they see in it. While this is natural, it is important to leave emotion behind when working on this. If you are asking yourself, “How do I go about calculating the value of my business?” you may want to consider bringing in an outside expert who has not put their heart and soul into developing and building the business in question.