E is for Equity: Breaking Down Your Business’ Worth

Are you someone who is thinking of selling your business? Putting a price to a business can be a somewhat challenging process. Oftentimes, what you think your business is worth and what a potential buyer’s idea of what your business is worth will differ. In an ideal world, everyone comes to a quick decision on how much your business is worth and you would all live happily ever after. Unfortunately, real life is a little different, which is why it is important that business owners know how to break down the worth of their enterprise. In today’s article, we have a look at how you can accurately value your business in order to get the best deal, so read on to find out more!

What Is A Buyer Looking For?

The most important aspect of valuing your business that you will need to get your head around is how much profit it will make your buyer, balanced by the risks involved. Yes, there are simple measures of worth such as consistent cash flow, a healthy balance sheet, asset values and profitability. However, a large chunk  of your business’ worth also comes down to immeasurable factors such as goodwill, key business relationships and reputation. 

What Affects Business Viability?

There are three main factors that affect the viability of your business:
 

• Years Of Operation

 
When it comes to years of operation, the longer your business has had a history of operating, the better. This is because you will be able to provide a better track record, history of cash flow and loyal customers that provide repeat business. Most investors or potential buyers will be a little wary of a business that has only been operating for a year or two as the risks involved in purchasing a startup are a lot higher than they would be with a well established business. 
 

• Tangible VS Intangible Assets

 
The second way of valuing your business is to have a look at your tangible vs intangible assets. Tangible assets include stock, materials, cars, machinery and products. Intangible assets include reputation, customer loyalty, intellectual property and the potential for growth. Most businesses have a lot less tangible assets than they do intangible assets, making it slightly harder to value the actual worth of the entire business. This is where hiring an accountant can be incredibly helpful. Your accountant will be able to measure the worth of your intangible assets much better than you would be able to, and it is always recommended that you heed your lawyer’s advice when it comes to the valuation of your assets so as to not undervalue your intangible assets. 
 

• Circumstance of Sale

 
Is there a particular reason you are looking to sell your business? The reasoning behind the sale of your business contributes greatly to its value. Say for example, you are just looking to finally retire. Compare that to a business that has been forced to sell due to financial issues or uncertainty. Which one do you think has better value for a potential buyer? The former, of course. The circumstances of your sale play a big part in how much a buyer values your business and in general, the longer you spend on negotiations instead of just receiving the first offer you get will make a much better impression on potential buyers. 

Common Valuation Methods: 

Here are the three most common valuation methods that business owners can use: 
 

• Valuation of Assets

 
Simply add up the assets of your business and subtract your liabilities. The sum of that equation will be a very vague estimation of what your business is worth. The starting point for asset valuation will be the assets listed in your accounts, also known as net book value. You may then choose to refine this figure based on issues such as change of value in property/fixed assets, unpaid debts and intangible assets such as company reputation, goodwill and customer loyalty. 
 

• P/E Ratio

 
P/E ratio, or price-earnings ratio, is the value of your business divided by profits after tax. A simple equation used for valuing a business based on P/E ratio is: Value = Earnings after tax × P/E ratio. 
Once you have decided on your ratio, simply multiply by your most recent profits. you multiply the business’s most recent profits after tax by this figure. With that said, deciding which P/E ratio to use is not a simple task though some industries have ‘standard’ P/E ratios for valuing a business. It is always best to consult your accountant when it comes to P/E ratios. 
 

• Entry Cost 

 
An entry cost valuation reflects what the process of starting a similar business from scratch would cost a potential buyer. This will include the costs of purchasing assets, developing products and services, recruitment, training and building up of a customer base. A business that already has all these components is often worth a fair amount, and we recommend talking to your accountant and lawyer in order to come up with the sum of entry cost. 

What About Intangible Assets?

Intangible assets such as strong relationships with suppliers, goodwill, customer loyalty, and management stability can also greatly boost the value of your business. Of course, coming up with an exact sum of how much is something that is best left to the experts. We always recommend talking to your accountant and review the IP Australia website for steps you can take to enhance the value of intangible assets.
We hope that this article has given you some insight into how you can go about breaking down your business’ worth.