How Business Valuation Is Calculated

Business valuation is required to determine the asking price for the entity when the owner decides to sell the business online. It is a prerequisite for the selling process and must be calculated by a professional accountant to determine the right pricing. They can objectively assess the worth of the venture using proven accounting methods and industry standards.

Computing the value of the business requires an in-depth analysis of its growth stage in the lifecycle, revenue, expenses, taxes, assets, liabilities, etc. It is vital to know this amount before putting the business for sale. So, here is a look at all the methods of calculating business valuation to know the economic value of the entity. These techniques require collecting and assessing all the financial and business data to identify the correct value.

Methods of Business Valuation

Entrepreneurs planning to sell their business online to secure a desirable retirement fund must know the different ways of business valuation used by accountants. These include:

• Book Value Method

The easiest way of gauging business valuation is to use the book value approach. It involves subtracting the total liabilities of the entity from its total assets to calculate the owner’s equity. It is used by those who want to sell their business quickly. However, it is not considered to be an accurate evaluation of the business value because of the complexity related to the calculation of depreciation of assets and intangible assets.

• Market Capitalisation Method

Also known as market value, the market capitalisation method is used by entrepreneurs who wish to sell business online or have received merger offers. It is calculated by multiplying the share price of the business by the total number of outstanding shares. It keeps changing as the price of the share changes by 3% to 5% in a day. Most experts do not rely on this method because it determines the value of the business based on the stock market.

• Return on Investment Method

Selling a business online requires creating a business listing that includes the asking price. Thus, entrepreneurs can use the return on investment method to calculate this amount. They can ask their accountant to provide net annual profit and the predicted return on investment figures and place them in the formula below:

Business valuation = Net Annual Profit / Return on Investment x 100

You can set a fair price for the business by predicting a relevant and achievable ROI.

• Cost-to-Duplicate Method

A few accountants calculate business valuation by determining the cost of starting the business from scratch in the current market. Thus, they check the cost of buying land or lease, equipment, employing workforce, procuring stock, manufacturing, distributing, marketing, etc., to find this value.

It considers all the expenses related to starting up to identify the value. However, it is again considered inaccurate because it does not include intangible assets like goodwill that the business has gained over the years and its future potential. Thus, you should avoid the mistake of relying on one method and try other valuation methods.

• Discounted Cash Flow Method

The discounted cash flow method involves estimating the future cash flow of the business in the next five to ten years. Its formula is as follows:

Discounted Cash Flow = Terminal Cash Flow / (1 + Cost of Capital) number of years in the future

It requires making assumptions about the projected future cash flow, which may be inaccurate and affect the valuation.

• Enterprise Value Method

When entrepreneurs decide to sell business online, they can use the enterprise value method that takes into account the debt and equity of the entity. The formula is as follows:

Enterprise Value = Debt + Equity – Cash

Here, the cash is the amount that is not utilised in operations. It is considered an accurate measure of the business value compared to the market capitalisation method.

• Asset Valuation Method

This valuation method involves identifying what the business owns and what it owes to others. The formula for this valuation is as follows:

Net worth = Assets – Liabilities

The assets should include the tangible (equipment, commercial property, vehicles, inventory, etc.) and intangible assets (goodwill and intellectual property). Also, the accountant must keep the depreciation of assets in mind while evaluating the cost of assets.

• Comparable Sales Method

The comparable sales method also works when you wish to sell business online. It requires finding out the sales price of similar businesses sold in the industry recently to know the trending rates. It allows understanding the market trends and consumer sentiment.

Entrepreneurs can look at the market value of other similar businesses to get this amount. It can be used by entrepreneurs who can gather data about several similar businesses getting sold in the same marketplace. Also, external factors like inflation and the economy must be stable during this period.

Wrapping Up

When entrepreneurs plan to sell business online, they need to find out the economic value of their business. It is needed to set the asking price, which has room for buyer negotiations. They must use the valuation methods mentioned above to know this amount and seek guidance from their accountants.