What is a Business Valuation?
A business valuation is designed to show a business owner how much their business is worth. Understanding this worth is vital for future planning and decision making as well as providing a business owner with the ability to put a value against the effort they are putting into their business.
A previous study conducted by Prospa showed that over 26% of small business owners are working in excess of 50 hours per week, and similarly 24% are working 7 days a week (Prospa Group Limited, 2019). With all this time and energy being spent it is important that steps are being taken to measure the contribution. This is where a business valuation can be of assistance.
Reasons to complete a Business Valuation
Business valuations can be used for a whole host of purposes, making them an essential piece of information for business owners.
We have outlined below some of the more common reasons for obtaining a business valuation, noting that many of these reasons are reactive in nature, completed as a result of a specific need:
1. Selling Your Business
A business valuation will provide you with an unbiased document that can be given to potential buyers that can be used to sell your business/or portion of your business – will help you to be confident you are selling your business for its true worth.
2. Buying a Business
A valuation can be completed for a potential business to ensure the price you pay is one of fair value.
3. Entry Cost to Market
As opposed to buying a business you could look to start a similar venture from scratch and need to compare an existing business using a business valuation to that of start up costs.
4. Attracting Investment
The business may wish to explore capital raising and in order to provide something to potential investors, they will want to see a current valuation before contributing.
5. Insurance Cover
Buy/sell life insurance agreements, business partners life insurance policies and other types of insurances need to reflect a true, fair and up to date market value as insurance companies may only payout a portion of the value if the cover has been undervalued.
6. Separation/Loss of Significant Individual
This can be a difficult and highly emotional time so having the ability to rely on the information required to deal with ongoing operation and exit strategies can be assisted through a business valuation.
A less common reason to obtain a business valuation but one that we see as being critical in assisting business owners with the information they need to plan and make decisions associated with their business and eventual succession is to assess any business value gap.
The Importance of a Business Valuation
Business owners will often overvalue their business, being their prized asset, and leave their exit strategies to the last minute. This lack of planning can result in a disconnect between the owners perception of value and what a potential buyer is willing to pay, leaving the owner with no choice but to sell at a lower rate, potentially impacting retirement plans.
Understanding the business value in advance of considering any exit strategy can serve as a reality check for business owners that may have a biased or uninformed viewpoint on their business’s actual value. Any disconnect between the business owner’s perceived value and the actual value is termed the “business value gap”.
Identifying that a business value gap exists early on in the piece can provide business owners with the opportunity to make changes and improve their business value in order to maximise their return on its eventual sale.
How is a Business Valuation Completed?
There are many ways you can look to obtain a business valuation but it is definitely an area that you should not take shortcuts in. Your ability to be confident that the valuation is supported by accurate data and results is vital given the information will be used to make a number of operational and future planning decisions.
There are three key business valuation methods that are generally accepted:
1. Asset Valuation Method
Calculates the value of tangible and intangible assets;
2. Discounted Cash Flow Analysis
Determines the present value of future opportunities or cash flow;
3. Capitalisation of Profit
Multiplies a business’s adjusted net profit before tax by a capitalisation rate (or business cap rate), which is specific to each business at a particular point in time. This particular method offers the ability to value not just a business’s profit performance or asset value but will also factor in qualitative factors ascertained from a risk and value driver assessment completed across a range of areas, each of which are outlined below.
Advocating the Capitalisation of Profits Method
We are advocates of the Capitalisation of Profits method given the global approach it takes to assess a business value.
The Capitalisation of Profit methodology considers three areas to determine the value:
Area 1: Profitability & Cash Flow
Does the business generate sufficient available cash flows after tax (from profits) to provide a return and yield on the business’s assessed value (this includes consideration of the free cash flow factor of the business);
Area 2: RAVDA
This assesses the business’s qualitative risk and value drivers across the following areas:
- The Industry
- Management Information Systems
- Customer and Market Demand
- Finance, Valuation, Succession and Estate Planning
Area 3: Cost of Funds
An acceptable yield rate to the owner/investor.
Do you need a business valuation?
If you are not sure what your business is worth or would like to see whether you have a business value gap, we can help. You can take our complimentary Business Valuation Survey to receive your personalized Business Valuation Scorecard which will provide you with some initial indicators of areas you may wish to consider in your business. You will find the survey by clicking here.
We are always here to support you. If you have any questions regarding business valuations, please contact your Davidsons team member on 03 52216399 or email at firstname.lastname@example.org.
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Disclaimer: This information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.
This article was written by Davidsons Tax and Business Services Manager Daniel Neeson.
Prospa Group Limited (2019) The Economic Impact of Prospa Lending to Small Business, Prospa Group Limited, accessed 3 March 2022.