Partner Logo
Home  > Business Valuation Methods
 Share  Print Version  Email

Business Valuation Methods

Simple Alliance, Kenya Limited


Definition

Business valuation is the process of establishing the market worth of your venture. This worth hinges on your business’ capacity to consistently earn profits.  Such ability derives from your business’ cash flow. 

Purpose

You would undertake business valuation on a number of instances, including:  

  • If plan to sell or buy some business
  • When reorganising your business
  • When doing estate planning
  • To verify your worth to investors and lenders

Selling or Buying a Business

When contemplating selling or buying a business, your valuation ought to be guided by the desire to arrive at an approximate value. This is because sellers and buyers rarely concur with regard to suitable valuation methods. The end result is usually conflicting value figures.    

Major Valuation Methods

The main valuation approaches you could employ include:

  • Asset valuation
  • Owner benefit valuation
  • Market or multiplier valuation
  • Capitalization of income valuation

Asset Valuation

This method applies to asset-intensive firms. Key examples are manufacturing establishments and retain ventures. The total asset value determines your business’ market value.  Some elements to take into consideration include:

  • Fair market value of fixed assets (FMV/FA) and equipment
  • Inventory (I)  
  • Leasehold equipment
  • Owner benefit (OB)

FMV/FA

The (FMV/FA) is the prevailing market price you would pay for your equipment and assets.

Inventory

Some inventory items to consider include:

  • Finished product value
  • Work in progress
  • Raw material value

Owner Benefit

OB represents seller’s optional cash for a year. Obtain the OB figure from your adjusted income statement. 

Leasehold Equipment

The LI represents modifications on physical assets that would be factored in if you were not renewing a lease or not selling the property.

Owner Benefit

This method is mostly used for ventures whose value derives from their capacity to create cash flow and profits. It emphasises seller’s discretionary cash.

Formula

Owner Benefit × 2.2727 = Market Value

The 2.2727 multiplier considers standard values like:

  • A living salary equivalent to thirty percent of owner benefit
  • A ten percent return on investment
  • A 25% debt service

Capitalization of Income

The capitalization of income valuation method is applicable to non-asset-intensive establishments, for instance, service firms.  It factors in more intangible assets while not quantifying the values of fixed assets.

Factors for Consideration

You need to take into account certain factors when using the capitalization of income valuation method. The factors include: 

  • Technology
  • Owner’s motivation for selling
  • How long the firm has been operational
  • Customer base
  • How long owner has owned the venture
  • Future prospects for the industry
  • Level of risk
  • Entry barriers
  • Profitability
  • Growth history
  • Competition
  • Location

Manipulating the Factors

It is recommended that you go by certain steps so as to arrive at a business’ market value. The steps are:

  • Assign every factor a rating of zero to five, with five representing the most positive rating
  • Compute the capitalisation rate by getting the average of the above factors
  • Multiply the capitalisation rate by buyer’s discretionary cash to arrive at the market value
  • To arrive at the average capitalisation rate value, add up the ratings and divide by twelve
  • Calculate buyer’s discretionary cash by multiplying owner benefit by 75% 
  • Multiply owner benefit by capitalisation rate to obtain the market value  

Market or Multiplier Method

With this method, you use a multiplier derived from industry average sales figures. To get the multiplier, different businesses’ gross sales figures are gathered.  An industry formula is then generated.

Obtaining a Suitable Multiplier

You have 2 options:

  • Consulting a knowledgeable appraiser or broker
  • Contacting your industry association  

Demerits of Multiplier Formulas

The multiplier method has several demerits, including:

  • They fail to consider that similar businesses within the same industry could be different
  • The fail to emphasise cash flow or bottom line 

Valuing a business venture is a valuable exercise when contemplating purchasing or selling an establishment. You could also value a business in case you are anticipating reorganising your estate, confirming your worth to lenders, or planning your estate. There are various valuation methods at your disposal. Key ones include; Asset valuation, Owner benefits valuation, Market or multiplier valuation, and Capitalization of income valuation.

Copyright (C) 2016, Simple Alliance Kenya Limited

 Share  Print Version  Email
Comments &Ratings (0)
If you are a human, do not fill in this field.
Click stars to rate.
   Comments are truncated at 1000 characters