Considering what your business is worth is essential for any business owner when making decisions. But it’s not just good for identifying the purchase price in the event of a sale or acquisition; it can also be used to establish partnership agreements or dissolution, resolve disputes relating to estate and gift taxation, or even assist in something as left-field as divorce settlements and proceedings.
Most usefully though, you can use a business valuation to grow your business.
But your business might be worth different amounts depending on how you look at it.
Why does the value of a business change?
As business valuation is an extremely versatile tool, there are many ways in which a business valuation can be performed. Depending on the way the valuation is conducted, the outcome may change.
How do I decide which kind of valuation is right?
To decide what method of valuation is right, you need to identify the main reasons a valuation is being performed. This idea is known as the ‘premise of value‘. This is basically the assumptions made about where the most value lies in the business, and it will determine the method of valuation.
Assumption one: The value of the business
You can make one of two assumptions about the business itself which will determine the focus of the valuation:
- 1. Is the business worth more in its liquidation (termination, breakdown and sale)? If this were the case, one would choose a valuation method that would focus on the asset value of the business and discount the ability of those assets to generate wealth in the future; or
- 2. Is the business worth more as a going concern? This refers to the assumption that the main value of the business is in its ongoing operation. In this case, one might choose a valuation method that focuses on the return of investment over time.
Assumption two: fair value for more than one party
If the valuation is being used to determine value for more than one party (for example in a purchase situation, or when a partnership is involved), you need to make an assumption in relation to the ‘fair value calculation’. Basically, this is asking, “what is going to result in the fairest valuation for all parties?”. Again, you can make one of two assumptions about this:
- 1. The business’ value is ‘in exchange‘. This means the business is most valuable to all parties when considered alone because the individual assets of each party do not confer inequality in the value of the business; or
- 2. The business’ value is ‘in use‘. This refers to the assumption that the business is most valuable when considered in combination with other related assets, for instance specific competitive advantages one party may have over others.
A more simple way of valuing your business
For those business owners who are simply interested in gaining insight on the ‘problem areas’ within the business, the valuation method is less important than the ratio analysis.
A ratio analysis is a key part of any valuation process, and one that should be done regardless of any other considerations. Essentially this process is where you would look at the books to see what the cashflow, turnover and profit-margins are.
The ratio analysis, alongside the assumptions about the premise of value, provide deep insight into the inner workings of the business and clarity as to what areas need improvement to increase the outcome value of the valuation.