Regardless of what anyone tells you, determining the value of your business is a subjective process. The value of a business in one person’s hands can be completely different to another.
However, there are a variety of methods to determine the value of a business. Some methods are fairly simple and others are a bit more complex.
Three approaches to determine business value
1. Net Asset Value
Perhaps the simplest method that can used to value your business is to determine its Net Asset Value (“NAV”). This simple method entails subtracting the value of the liabilities from the value of the assets.
2. “Multiples” Approach
Another method that can be used to value a business is to apply a specific multiple to a financial metric. This method is referred to as a “multiples” approach. For example, a company’s net profit could be multiplied by a specific number to give you a value of the business.
The number which you multiply the earnings by is referred to as a “Price Earnings” or “PE” multiple.
The size of this number will depend on the business in question, for example its growth prospects, its size and the industry in which it operates, just to name a few.
3. Discounted Cash Flow Method
The final approach that can be used to value a business is the discounted cash flow (“DCF”) method. This method adopts the philosophy of “Cash is King.” Under this method, the business is valued using cash flows that the business is expected to generate.
Cash flows can take the form of future dividend payments or if the business pays a small or even no dividend, cash flows can take the form of profits generated by the business after adjusting for future capital expenses, investments in working capital and taxes payable.
As this method values a business using the cash flows it is expected to generate in the future, a discount needs to be applied to these future cash flows (to reflect the uncertainty thereof), the size of which increases the further out in the future the cash flow occurs. The aggregate value or sum of these discounted cash flows represents the estimated value of the business.
The three valuation methods (NAV, multiples or DCF) mentioned above can yield different values for a business and deciding which method to use will often depend on the purpose of the valuation as well as the specific business being valued.