Factors That Affect Valuation of a Business

A business is valued to determine its worth, share price, or when it is intended to be sold or transferred. A business valuation is performed in accordance with established procedures. Business owners are not advised to attempt to value their own property and business. The cost of a professional valuation depends on the business’ size and development.

A business’ value not only includes its operations and balance sheets, but is also associated with

  • industry conditions,
  • economic conditions (nationally as well as locally)
  • intangible assets (copyrights, trademarks, and patents),
  • current leases or business-owned real estate, and
  • stock (rights of refusal and transfer restrictions).

How Is Business Value Measured?

A business is valued according to its value standard. That is, all conditions that affect and impact the business and its operations are factored into the business’ stability of value. Similarly, the business’ value must also consider the projected worth or premise of value. The premise of value assumes the business will continue its current operations and profitability indefinitely. Premise of value also considers how the proceeds from the sale of the business will offset current business debt.

Various analyses are performed to determine business valuation. Financial statements show the business’ financial condition including its size, profitability and liquidity over a period of time and may be used to determine trends that impacted it and similar businesses within the industry. Adjustments are made to account for industry trends that affect the business as well as comparable businesses, non-operating assets such as cash the seller will retain after the sale, and distributions and compensation.

Methods used to value a business include:

  • The Income Approach that calculates the net present value, or, the business’ discounted cash flow; the average (predicted) future earnings is divided by the capitalization factor,
  • The Asset-Based Approach that calculates the (after-tax) net asset value by adding all parts of the business together;
    – a Going Concern asset based approach uses balance sheets that show the assets minus liabilities, and
    – a Liquidation asset-based approach determines the net cash left when all assets are sold and debt (liabilities) is paid,
  • The Market Approach that compares the business to similarly-sized businesses within the industry in the same geographic region; this method works when there are an adequate number of similar business types with which to compare.

The income and market approaches are often used collectively by private equity investors and venture capitalists to determine a business’ worth.

What Directly Affects The Business’ Value?

Direct factors that affect the valuation of a business include:

  • historical earnings and expenses reports,
  • market demand,
  • overall business and operations conditions including personnel and labor, equipment, records, and facilities,
  • capital, liquidity, and economic conditions that affect the business’ survival,
  • competition and the business’ sustainability,
  • the ease of transferring intangible assets after the sale is closed,
  • potential growth and profit,
  • excise (tax) consequences from the transaction,
  • cash/terms exchange, and
  • the potential buyer’s business value synergy.

Julie Harrison is a blogger at TBB. She loves to write awesome tips about buying and selling your business.

 

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