Most business owners have probably asked themselves at one time or another how much their business is worth. It can be a difficult question to answer, but it’s essential to know the value of your business to make sound decisions about its future.
Whether you’re looking to sell or want a better understanding of what your business is worth, this post is for you. We will discuss simple ways to value your business, including using valuation tools and standard valuation methods. So without further ado, let’s get started:
1. The Income Approach
The first way to value your business is the income approach. This approach is most commonly used when valuing established businesses with a history of financial performance. It values your business based on the projected future economic benefits it will generate or what it is expected to earn in the future.
To calculate the value using the income approach, you need to project future earnings and then discount those earnings back to the present. The discount rate you use is typically your weighted average cost of capital.
2. Market Capitalization
The market capitalization of a business is simply the value of all the shares of stock outstanding multiplied by the current market price per share. So, if a company has one million shares outstanding and each share trades for $20, the market cap would be $20 million.
This is the most common way investors value a company, and it’s the number you’ll see quoted often when a company’s stock price is reported. While it’s a good starting point, there are problems with using a market cap to value a business.
For one, the market cap doesn’t consider the company’s debt, including bad credit cash loans. It also doesn’t reflect the company’s future cash flows or earnings. Finally, the market cap can be affected by factors unrelated to the underlying business, such as investor sentiment.
3. The Asset Approach
This method values your business based on the fair market value of its assets. The asset approach is most commonly used when valuing businesses in the early stages of development or businesses that don’t have a history of financial performance.
To calculate the value using the asset approach, you need to add the fair market value of all your business’s assets and subtract any liabilities.
4. The Market Approach
The market approach is based on the principle of supply and demand, and it values your business based on what similar businesses have recently sold for.
To calculate the value using the market approach, you need to find out how much similar businesses have sold for and adjust that number based on any differences between those businesses and your business.
5. The Discounted Cash Flow (DCF) Method
The DCF method is a more detailed version of the income approach. It estimates the present value of all future cash flows that a business is expected to generate and uses the discount rate to reflect the riskiness of the cash flows based on the cost of equity capital.
Larger, publicly-traded companies most often use this method because it is more complex and requires more information than the other methods. However, the DCF method can be used to value any business.
To calculate the present value of future cash flows using the DCF method, you will need to estimate the following:
- The amount of cash that the business is expected to generate in the future
- The discount rate to use
- The terminal value of the business
Once you have estimated these three items, you can calculate the present value of future cash flows.
6. Earnings Multiplier
The earnings multiplier is the most simple and effective method of valuing your business. By considering your company’s earnings, this multiplier provides an accurate estimate of your business’s value.
Divide your company’s annual earnings by the multiplier to calculate the earnings multiplier. The multiplier will vary depending on the industry but is typically between one and five. For example, let’s say your company earned $100,000 last year, and the multiplier for your industry is four — it means that your company is worth $400,000.
7. Times Revenue Method
This valuation method assumes that a company’s value equals a multiple of its revenue. For example, if a company’s revenue is $100 million and its multiplier is four, its value would be $400 million.
To calculate a company’s value using the times revenue method, multiply its revenue by the chosen multiplier. This formula can be a helpful tool for valuing a business, mainly in conjunction with other methods.
These are the seven simple ways to value your business. Regardless of your chosen method, always remember to be realistic in your assessment because under or over-valuing your business can have severe repercussions down the road. If you’re unsure where to start, a qualified business appraiser can give you an objective opinion on your company’s worth.