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You must determine how much a business is worth anytime you sell part or all of it, and there are several business valuation methods that entrepreneurs and investors might use to evaluate a business's worth. Here are some commonly used business valuation methods.
Asset-Based Business Valuation
An asset-based business valuation is the most straightforward of these methods, although there still is some ambiguity involved. With this method, a business's worth is determined by adding up the value of all the assets that the business owns and subtracting all of the outstanding liabilities that the business has.
For example, assume you own a business that has a building worth $100,000 and equipment worth $25,000. Also, figure the business has a loan for $10,000. The business' assets would add up to $125,000 and its liabilities would be $10,000 (not including interest), for an asset-based valuation of $115,000.
Ambiguity can arise when tabulating how much different assets would sell for, but usually, different parties can eventually agree on how much different land holdings, buildings, pieces of equipment, and supplies are worth. Once there's agreement on the worth of individual assets, the business valuation is then simple math.
Earnings-Based Business Valuation
An earnings-based business valuation doesn't focus on the tangible assets that a business has but rather how much the business earns. Importantly, earnings shouldn't be confused with gross revenue. Gross revenue is how much a business has in sales. Earnings refer to the profit that a business actually makes after all expenses are taken into account.
For instance, consider a business that sells $400,000 worth of products each year but has $350,000 in expenses annually. This business's annual earnings would be $50,000.
Earnings-based approaches may look at past earnings or potential earnings. If past earnings are used, recent earnings are often more important than earnings from long ago because recent ones show how a business is trending. If future earnings are used, there may be ambiguity regarding a business's potential that investors must agree on.
Market-Value Business Valuation
A market-value business valuation focuses less on the business itself and more on similar businesses. This approach examines how much comparable businesses have sold for and determines a value accordingly.
When selecting comparable business sales to use, the businesses chosen should be in the same industry and have approximately the same number of sales as the business that's being evaluated. The comparable ones would ideally be in the same region too, but that's not always possible to find.
Share24 January 2020
