If you own a business, one of the professional things you need to do is to value the business. Interestingly, valuing a business is not solely for people who want to sell their business. Even if you want to buy or apply for a business loan for your business, the value of your business would be required hence the need to make sure you value your business as often as you can, preferably bi-annually.
We are not ignorant of the fact that valuing a business can somehow be tasking and perhaps complex. It goes beyond the collection or compiling of all the key financial data around your business’s transactions and assets – it will require deep industry research and calculations. In this article, we will give you a step by step guide on how to value your business in Australia.
3 Simple Steps on How to Value a Business for Sale
Table of Content
STEP ONE: Compile Your Business Information
The first step to take if you want to value your business is to compile your business information. You would need a range of business information to value your business properly. If you need help with preparing your documents and can’t afford a professional, consider asking friends or family with bookkeeping or business experience.
Please note that, if you are selling, potential buyers may ask to want to value your business independently. So, it is a good idea to have your business documents organized and up-to-date. You will probably need the following information.
Finances and Assets
- Your financial statements (for the last 5 years if possible) such as cash flow statements, debts, annual turnover, and profit and loss statements.
- Details of physical assets such as machinery, buildings, equipment, and stock.
- Details of other assets such as goodwill towards the business and intellectual property (any designs or ideas that you have protected through copyright).
- Legal documents such as leases and insurance policies.
- Registration papers such as business name certificates, Australian business number (ABN) registration papers, licenses, permits, and any other papers that demonstrate you comply with government requirements.
Business Profile, Procedures and Plans
- Market conditions such as details of competitors, and how your business compares to them.
- Sales information such as reports and forecasts.
- Business history such as start date, ownership and location changes.
- Business procedure documentation such as marketing, staff roster and customer service procedures.
- Business plan such as marketing, emergency management and growth plans.
- Other details such as opening hours and whether the business premises are owned or leased.
Staff, Supplier and Customer Information
- Employee details such as job descriptions, skills and experience, work history, performance reviews, and pay rates.
- Supplier details such as supply agreements and supply prices.
- Customer details such as customer numbers, customer profiles and direct marketing activities.
STEP TWO: Conduct Due Diligence
If you have succeeded in compiling all the business documents and drawing up a rough estimate of the value of the business, then the next step to take is to conduct due diligence and preliminary investigation of the business, especially if you are buying a business. No experienced business man or woman will put an initial offer to buy a business without first conducting due diligence or asking the right questions.
Usually, due diligence is performed by the buyer, his or her accountant and attorney after the intent to purchase has been signed but before the formal purchase agreement. The essence of conducting due diligence before a business is purchased is to allow you to thoroughly examine the business to get the actual value of the business so you can make an informed decision before purchasing.
STEP THREE: Choose a Valuation Method
Please note that there are various types of valuation methods hence the need to choose a valuation method or a combination of valuation methods that will help you get an accurate result. You may also need to negotiate the method of valuation with a buyer or investor.
For instance, if you use a professional, they can help you decide which method is best for your business. Some common methods for calculating the value of a business include using:
- current market values
- return on investment
- business asset value
- cost of starting a business from scratch
- future profit of a business
Look at Current Marketplace Value And Your Industry
Please note that how you value your business can depend heavily on the industry you are in, and the current marketplace value of similar businesses. Industries usually come up with their own rules and formulas to value a business. So, it is a good idea to get a good understanding for your particular industry.
Use The Return On Investment Method To Calculate Value
Please note that if you are selling your business, the return on investment (ROI) method uses your business’ net profit to work out its value. You can either calculate:
- an ROI based on a selling price (value) you have in mind, or
- a selling price based on an ROI that you set
ROI = (net annual profit/selling price) x 100
For example, you have a selling price of $400,000 in mind, but want to test your ROI based on that price. You calculate that your business’ net profit was $100,000 for the past year.
To work out the ROI, you use the formula:
ROI = (100,000/400,000) x 100
In this case, your ROI is 25 percent.
If you have an ROI in mind, you can use it to calculate the price for your business:
Value (selling price) = (net annual profit / ROI) x 100
Say you wanted a ROI of at least 50 percent for the sale of your business. If your business’ net profit for the past year was $100,000, you could work out the minimum selling price you should set.
Selling price = (100,000/50) x 100
In this case, to achieve a ROI of at least 50 percent, you will need to sell your business for at least $200,000.
Use Your Business’ Assets To Calculate Net Worth
Please note that when calculating the value of your business assets, you must make sure you include both tangible and intangible assets of your business.
- Tangible assets are physical things you can touch such as tools, equipment, and property.
- Intangible assets are things that can’t be touched but are still valuable, such as intellectual property, brands and business goodwill.
After you’ve calculated the total asset value of your business, use this as an indication of how much you’d like to sell your business for. Assessing your business’ assets value can be a complicated process. It is a good idea to ask your business advisor or accountant for help.
Calculating Business Goodwill
Goodwill can include:
- customer loyalty and relations
- brand recognition
- staff performance
- customer lists
- the reputation of your business
- business operation procedures
Calculating goodwill can be a complicated process. You will get different results depending on the method you use. You can use different methods to get a price range you’d like to set for your business goodwill. But in the end, the value is what the marketplace or buyer is willing to pay.
Because it is difficult to calculate goodwill, it is a good idea to consult a professional such as your accountant.
Account for depreciation
If you use your business assets to calculate the value, remember to account for depreciation. Depreciation is the loss of value for your assets over time. For example, you may have purchased a computer for your business 5 years ago for $2000. When calculating your business’s asset value, the value of the computer will no longer be $2000.
It is advisable to talk to your accountant if you are not sure on how to work out the depreciation of assets.
Find The Cost Of Creating Your Business From Scratch
Please note that the cost of creating your business from scratch can be used as a guide for valuing your business. This is the estimated cost to build a similar business in your industry in the current market. To calculate the cost, you will need to include all costs involved when starting from scratch, like:
- buying stock
- buying equipment and tools
- getting licenses and permits
- recruiting, training and employing staff
- developing products
- marketing and promotion
- buying or leasing premises
- setting up online
Estimate The Future Profit Of Your Business
For a buyer or investor, the biggest value of your business will be its future profits. You are more likely to get finance or sell for a good price if you show your business will probably be profitable. Show this through your financial statements to give investors an idea of the returns they could expect from your business.
Estimate the future profit of your business by looking at trends in your business finances from past years. You can also look at trends for similar businesses in your industry. This can show how your business compares and how the market is going. Use this information when negotiating finance or a selling price for your business.
The above steps are the basic steps you need to take for the valuation of any business. Please note that you can actually value a business yourself, but if you don’t have the required experience or expertise, then it is advisable to hire a business consultant.
The business consultant should be able to help you analyze your finances, find trends in your industry’s market, calculate the goodwill value of your business, estimate your business’ future profit and of course, work out a value for your business.