Most business owners can go through their entire life without ever valuating their business’s worth. However, whether you are scouting for potential investors or looking to sell your business eventually, it is important to keep track of your business’s value and know what goes into the calculation. That is why I decided to write this post and introduce three different approaches to estimating the worth of your small business.
The Asset Approach: Out of all the valuation approaches there are, this one is the most concrete. Following this approach means placing a dollar value next to each asset the company has, whether tangible or intangible, and summing it all up together. Start with the physical assets, whose fair value is easier to calculate. Move on to calculating the value of patents, trademarks, brands, and incorporation papers. Last but not least, valuate the worth of your business’s relationships; assess the value of your employees and partners with whom you are in agreement, such as suppliers, business partners, and customers.
The Market Approach: This is the most common method to valuate a healthy business. Also known as relative valuation, this approach views the worth of your business in a competitive context. In order to calculate the value of your business, a valuation multiple relevant to your industry or market is calculated and standardized. Later that multiple is applied on the business asset that is being valuated, usually the EBITDA—Earnings Before Interest, Taxes, Depreciation, and Amortization. Therefore, if your EBITDA is 1 million dollars and your industry’s multiple is five, your business is worth 5 million dollars.
The Income Approach: This approach involves projecting the value of a company by estimating its future cash flows and discounting them at different rates. The rate is mostly affected by the uncertainty of the industry the company is active in. The discounted cash flow is considered the fair market value of the company in the present.
Two additional things to think about: First, valuating your business should be viewed as a powerful planning tool. Knowing what goes into the value calculation that is usually used in your industry can help you direct resources in the right direction in order to eventually increase your business’s value. Second, SMB owners’ personal and business expenses are often intertwined. Remember that in order to assess the value of your business accurately, you must first eliminate personal expenses that might have been included in the business operations.