Businesses are significant owners’ assets, and they are rightful to conduct their valuation. Business valuation is, simply put, a reliable assessment of the worth of the business. It is a dynamic process that includes examining countless variables, such as driving factors for the company, subjected laws, legal standards, etc., that contribute to the business.
Importance of Business Valuation
Company valuation experts are mainly required during business trading moreover, understanding how your business creates value, its strategic positioning, and the transaction landscape around you is critical. You might need it if your business is going towards a merger or acquisition. Therefore, business valuation is quite an emotional and personal process for the owner. Often, the business owners have an image of their company that is far from reality.
The importance of company valuation is critical for knowing your business’ worth so that you do not quote a wrong figure and end up underselling your business. Moreover, the buyers mostly consider the valuation process objective – depending on whether you have a financial or a strategic buyer. The perception of the business’s fair value is quite different for buyers and business owners.
No business owner would like to think their company is suffering loss or evaluated less than they had imagined. However, using an empirical method of business valuation by hiring the services of a highly trained business valuation in Ottawa can lead you to have a fair idea about your company’s standings.
Reasons for Conducting Business Valuation
The most critical element of conducting business valuation is to know the reason behind it. The choice of valuation approach also depends on the motive behind carrying out this process. Here are some of the various reasons owners conduct a business valuation.
- Selling the whole business or selling a share of it
- Possible business merger or acquisition
- Financial reporting
- Marital dissolution
It is pertinent to know the motive behind conducting business valuation as the purpose will help choose the suitable approach and applicable standard of value. For instance, according to the laws governing in some states, a marital dissolution case uses a fair market value standard for evaluating a business. A fair value standard is applied, independent of the current market value in other cases.
The Basis of Value
Another critical element in business valuation is the basis of value. It is the perspective of value from the point of view of both the parties involved in the transaction. The basis of value is directly linked to the purpose of valuation as they both play a role in determining the valuation approach.
An Overview of the Business Valuation Methods
Discounted Cash Flow
It is the most reliable form of business valuation method from a potential buyer’s perspective. What can be more dependable an analysis of the expected capital by the investor in the upcoming years? Using this business valuation method helps in assessing future sales and profits trends. The cash flow estimates are derived from the following points:
- Value of the business in today’s market standing to predict the future earnings
- The expected rate of the return on investment
- The probable equity share for the investor(s)
Estimating the potential cash flow leads to the discounted rate calculation by considering the value of the assets at the current time. The easiest way to understand this point is to know that this method analyzes the estimated profits of your company in the future.
The second crucial approach to evaluating a business is to assess its hard assets. Hard assets include the ones that are a critical part of the buying and selling process of the company, such as merchandise, equipment, sales, office supply, and inventory.
Goodwill is one of the vital assets of any business, and it is defined as the highlighted difference in the market value of the business and the actual worth of the hard assets. It is also determined by the customers’ loyalty, brand name and reputation, and the quality of customer services.
All these intangible factors included in the assets-based approach make this business valuation approach more credible than the previous one. For instance, if a restaurant going down the hill in business has its real estate evaluated at about a million dollars will have an edge using the asset-based valuation method.
Another critical approach for business valuation is the analysis of the financial worth of comparable businesses in the past. However, this method is hard to remain empirical and often leads to wrong assumptions.
An accounting firm, for instance, doing business for about twelve years has sizeable annual profits. Evaluating their business by considering the past years’ profits will lead to twelve times their yearly earnings on paper. However, in reality, the situation is very different. There are a lot of factors that impact the business valuation other than the calculated yearly profits, such as management size and depth.
Critical Steps Involved in Business Valuation Process
Heading in the direction of evaluating your business is critically linked with the performance of your business. If you have decided on conducting the valuation of your company, here are ten essential steps that you need to go through.
Hiring professional help
It is imperative to make the right judgment call and hire the services of a professional business valuation company so that the valuation is accurate. Every company is different, and principles applied to one business cannot be applied to another. Professionals in this business know their field and can carry out this task efficiently.
Clarify the purpose of the valuation
As mentioned above, the purpose of the business valuation must be clear. If the goal is unambiguous to all the personnel involved, the valuation can be accurate and fairly.
Basis of value
It is vital to undertake the fundamental objective of the valuation. It also clarifies the perspectives of the involved parties and is steered by business laws, regulations, and contracts.
Determining the premise of value
Both of the factors mentioned above help dictate the premise of the value. There are two main premises of value directing the business valuation process for any company. Either the company assets will be used in the same way and the operations will continue, or the assets will be sold, and the company will not continue doing business in the same manner.
Mergers and acquisitions also affect the premise of the value. This value increases substantially if the purchaser realizes that the acquired business is of more value than the projected fair market value.
A professional hired for business valuation draws a checklist for this process, including every kind of data the workers need for a valuation. It might include financial records, loan details, leases, business agreements, and other information.
Review of the historical performance
It is also essential to know everything there is about the company’s past performance. To compare a business to another comparable business, business valuators must know all the details about the company.
Future outlook of the business
This step is critical for an accurate business valuation. It is done by taking into account all the details about the current and future revenues of the business, its capital requirements, operating expenses, taxes, etc.
Determining the valuation approach
The next step is to decide on a business valuation approach. The professionals put their utmost hard work and intellect into determining the best approach.
The private companies need to have a discount applied to overcome the lack of ability to convert ownership stake to cash. Often, companies have a key a man discount, implying that the value of the business is associated with a high-profile personality, such as the founder, which increases the value.
Deriving the business value
The last and final step is determining the value of a business. This conclusion is backed up by a stack of valuation reports that are defendable and empirically derived.
The Bottom Line
Business valuation is a critical process that has numerous dynamic factors involved. Since every business’s business conditions and market environment are different, there is no stringent principle for conducting the valuation process in a specific way. Highly trained professionals in this regard work wonders for your company and draw a true and accurate valuation.