Combination of methods in company valuation

Q I AM a business owner and am looking at the option of selling my business. can you advise me on how to go about having the business valued?

A There are a number of methods available to calculate the value of a business. It is not a precise science but requires experience and judgement. As part of the sale of business you do need to have a business valuation.

When valuing a company, It’s quite usual to use some combination of the following techniques to determine the value.

VALUATION METHODS

Earnings multiples: Earnings multiples are commonly used to value businesses with an established, profitable history. Often, a price earnings ratio (P/E ratio) is used, which represents the value of a business divided by its profits after tax. To obtain a valuation, this ratio is then multiplied by current profits. Here the calculation of the profit figure itself does depend on circumstances and will be adjusted for relevant factors.

A difficulty with this method for private companies is in establishing an appropriate P/E ratio to use–these vary widely. As a rule of thumb, typically the P/E ratio of a small unquoted company is 50% lower than a comparable quoted company. Generally, small unquoted businesses are valued at somewhere between five and ten times their annual post tax profit..

Discounted cash flow: Generally appropriate for cash-generating, mature, stable businesses and those with good long-term prospects, this more technical method depends heavily on the assumptions made about long-term business conditions.

Essentially, the valuation is based on a cash flow forecast for a number of years forward plus a residual business value. The current value is then calculated using a discount rate, so that the value of the business can be established in today’s terms.

Entry cost: This method of valuation reflects the costs involved in setting up a business from scratch. Here the costs of purchasing assets, recruiting and training staff, developing products, building up a customer base, etc are the starting point for the valuation. A prospective buyer may look to reduce this for any cost savings they believe they could make.

Asset Valuation: This type of valuation method is most suited to businesses with a significant amount of tangible assets; for example, a stable, asset-rich property or manufacturing business. The method does not however take account of future earnings and is based on the sum of assets less liabilities. The starting point for the valuation is the assets per the accounts, which will then be adjusted to reflect current market rates.

Industry rules of thumb: Where buying and selling a business is common, certain industry-wide rules of thumb may develop. For example, the number of outlets for an estate agency business or recurring fees for an accountancy practice.

There are a number of other factors to be considered during the valuation process. These may help to greatly enhance, or unfortunately reduce, the value of a business depending upon their significance. A few areas to consider:

· Growth potential of the business

· External factors, such as state of the economy, the market the business operates in

· Intangible assets–Business valuations may need to consider the effect of intangible assets as they can be a significant factor.