Understanding what your business is worth and monitoring the trend in the value of your business can be very helpful in determining if you are reaching your financial and retirement goals. It adds to the information you need to decide if the investment (time & money) in the business is returning a reasonable return for your efforts in the form of salary and distributions as well the increase in value (sales price) of the business.
There are well established techniques to value a business.
The five most commonly used techniques are as follows:
- Discounted cash flow (DCF) analysis
- Comparable transaction method
- Multiples method
- Market valuation
- Asset valuation
A business owner often engages a business valuation professional to estimate the fair market value (FMV) of a business. FMV is defined as “the price at which a business would change hands between a willing buyer and a willing seller when the buyer and seller are not in any compulsion to buy or sell.” Hiring a professional to value your business can make sense from time to time. Often it is considered expensive by many business owners and, therefore they do not pursue the benefits of estimating the value of their business. There is another option.
Business owners can take it upon themselves to research their industry, as to what valuation methods are most often used in their industry to determine value. Discussions with professionals, such as a valuation professional, CPA’s, and business attorneys can be a resource to determine the most appropriate method(s) to value your business. Your CPA and in some cases, internal financial professionals, can be helpful to find the appropriate information to best value your business and to make the appropriate calculations.
No Professionally done valuation or self-generated valuation can totally predict at what value the business will actually sell. Only putting your business up for sale and receiving offers can give you the total picture. However, a properly thought through approach to valuing your business can give you valuable insight as to a range of value of your business, and assist in determining if you are making progress in increasing its value.
It is important to note that the true value can change over time. Economic conditions, customer mix, workforce in place, industry changes in competition, and other factors can have an effect on your business value. This is why it is important to consider those changes on a periodic basis to determine if you are utilizing the best approach to value your business, and in the case of income based models if you are using reasonable multiples.
Consider having a discussion with the professionals (CPA, Attorney) to explore how you might begin tracking the value of your business.