Tips for Assessing the Value of Your Small Business
Need to assess the value of your small business but not sure where to start? Read on for some useful tips to find out how much your business is worth.
Assessing the value of your small business can be difficult. Yet, there are many circumstances where you would be required to do so. For example, if you are considering selling your business or acquiring extra finance. Here are 4 useful tips to help you get started.
1. Make sure your business information is up to scratch
In order to assess the value of your business, you will need to compile different sets of important information together. You will need to support your valuation with some evidence, given that what you think your business is worth may not be the same as what others think. For reasons such as this, it is incredible important to always keep updated and accurate records of your business.
- Financial documents including your balance sheets, cash flow statements and income statements
- Asset information including any inventory, buildings or land, vehicles, equipment, intellectual property and goodwill
- Legal documents including any lease documents, registration papers (such as your Australian Business Number and Tax File Number), licences, permits and anything required for your business to comply with government requirements
- Other information including your business plan, any business reports, and information on key internal and external stakeholders (such as employees, suppliers and customers)
Ultimately, you want your business to be as appealing as possible by having information that proves it is profitable and will likely remain profitable in the future.
2. Understand the different valuation methods
Once you have compiled the necessary information, you will need to have a decent understanding of the valuation methods available. Common valuation methods include:
- Asset valuation method – This method gives you an idea of how much your business would be worth if it were to be sold immediately. Quite simply, you add the total value of your business’ assets together, and deduct the total value of your liabilities. However, this method does not take goodwill into account.
For example, using this method, if your business owns $500,000 worth of assets (such as inventory and equipment) and $50,000 in liabilities (such as an outstanding invoice(s) and loan(s)), your business would be valued at $450,000.
- Return on investment (ROI) method – This method uses your business’ net profit to calculate the value of your business. This is particularly useful if you are looking to sell your business, as you can calculate the selling price required for a specific ROI. The equation for this is: selling price = (net annual profit/ROI) x 100.
For example, using this method, if you were after a 40% ROI on the sale of your business and your business’ net profit was $200,000 for the past year, then your selling price should be $500,000. Working: (200,000/40) x 100
- Comparable sales method – This method compares the sales price of similar businesses to assist in the valuation of your business. This involves exploring recent sales of businesses of the same size, in the same industry and a similar location.
For example, using this method, if your business is a small toy store and recently, similar toy stores in the area have sold for $400,000, the value of your business would be a similar amount.
3. Select an appropriate valuation method
You do not need to pick and use one valuation method. In fact, you can utilise a combination of valuation methods. However, depending on your circumstances, you might need to agree on the valuation method being used with the relevant party. For example, if you are selling your business, the relevant party would be the potential buyer. You should also consider the industry of your business, as some may have different factors affecting the valuation method(s). For example, a mobile phone provider may have little to no profits, but its customer base will in itself represent a good amount of the business’ value.
4. Consider seeking professional advice
If you have the means, it would be worthwhile seeking professional advice on how to properly value your business. These concepts can be quite confusing and time consuming. To acquire some further assistance, contact an accountant or business lawyer today.
Samuel is a Legal Tech Intern at Lawpath, working as part of the content team. He is currently in his penultimate year of a combined Bachelor of Business and Bachelor of Laws degree at the University of Technology Sydney. He is primarily interested in commercial law.