How to Value a Business

There are various factors that come into play during the process of business valuation, including subjective interpretation, economic conditions and the reason for valuation. If the business is valued for sale, its worth depends on what's important to the buyer. One may believe the value is connected to its service to the community, while another may only consider income as the sole indicator of value. There are three fundamental approaches for determining the value of a business: asset, market and income.

Asset Approach

Step 1

Gather all business balance sheets to collect information regarding what assets have been purchased by the business. This should also include all assets that have been donated or transferred to the business, according to ValuAdder.

Step 2

Collect all necessary information regarding any inventory that may have been created within the business.

Step 3

Take into account any proprietary information owned by the business. This may include internally developed products and proprietary ways of doing business.

Step 4

Choose appropriate methods to value each asset. A common method is to consider the amount the owner paid for the asset to determine value. However, many assets are not purchased by the business owner, such as internally developed products and proprietary business methods. Add the sum of all values. The resulting figure provides the total value of the business.

Market Approach

Step 1

Check advertisements for similar businesses for sale. Depending on the type of business, it may be relevant to confine the search to local advertisements. The businesses sampled should be similar in size and scope. The more refined the criteria used for sampling, the more accurate the business valuation will be.

Step 2

Record the selling price of each advertised business.

Step 3

Calculate the sum of sampled businesses for sale. Divide this figure by the number of businesses sampled. This will provide the average price of similar businesses, which can be used as the fair market value of the business to be valued.

Income Approach

Step 1

Calculate the discount rate of the business by comparing the potential investment with other safer alternative investments, such as U.S. government bonds. The discount rate represents the required rate of return to make a business acquisition worth the invested amounted. If a business purchase is financed by both equity and debt, the discount rate can be calculated as a weighted average cost of capital.

Step 2

Calculate the capitalization rate by subtracting the expected annual long-term growth rate from the discount rate. Capitalization rate is the rate of return on an investment based on expected income the investment will generate, according to Investopedia.

Step 3

Divide the annual earnings of the business by the capitalization rate. This figure is the valuation of the business.

Sources

ValuAdder: Business Valuation: Three Approaches to Measuring Business Worth [http://www.valuadder.com/valuationguide/business-valuation-three-approaches.html]

ValuAdder: Capitalization Rate Definition[http://www.valuadder.com/glossary/capitalization-rate.html]

ValuAdder: Weighted Average Cost of Capital (WACC) Definition [http://www.valuadder.com/glossary/weighted-average-cost-capital.html]

Investopedia: Capitalization Rate Definintion [http://www.investopedia.com/terms/c/capitalizationrate.asp]

ValuAdder: Discount Rate Definition [http://www.valuadder.com/glossary/discount-rate.html]