How To Value a Business In 9 Expert Methods

Professional investors maintain the standard for financial evaluations in the world of business. They’re uniquely qualified to assess the risks associated with a particular investment and have the expertise to advise businesses on financial matters. One of the most important services a professional investor can provide is a business valuation.

What is a business valuation?

A business valuation, also known as a company valuation, is an in-depth review of a business’s assets and liabilities to estimate its current economic worth. Unlike a simple assets-minus-liabilities equation, a business valuation is extremely detailed and takes into account every area of the business (cost of capital, EBITDA, cash flow analysis, tangible assets, intangible assets, past market value, enterprise value, etc.) to factor it into the final valuation calculation.

This is a complex process that requires a thorough understanding of whichever business valuation methods the company chooses to employ. For this reason, many businesses choose to outsource the business valuation to a professional investor. However, it can also be performed by a well-informed business leader.

Why are business valuations important?

When properly conducted, a company valuation can provide insight into the business’s present value to help business leaders make informed decisions. You may need to know what the current fair market value of your business is in preparation for a big event such as selling your business and business stocks or merging with a new company. Sometimes company valuations are even required as part of divorce proceedings to ensure business assets are divided equally.

For some, a company valuation is part of the standard process for developing financial goals for a business and creating a value proposition. Many business leaders choose to regularly perform company valuations as part of their business management strategy because it provides key insights and a detailed cash flow analysis, both of which help with accurate tax reporting and business investment decisions in the future.

The Basics of Business Valuation

Learning how to value a business starts with choosing the right valuation technique. There are several business valuation methods that a company or professional investor might use to estimate a company’s present value and calculate profitability. Some investors and business leaders even like to use a combination of several valuation methods to get a more well-rounded view of the business’s worth and fair market value.

Here are the nine most common business valuation methods professional investors use to determine a company’s present value.

9 Company Valuation Techniques You Can Apply Today

Book Value

Arguably the simplest valuation technique, the book value method focuses on analyzing the data in a business’s balance sheet to determine its net worth. A reviewer would only need a copy of the company’s most recent balance sheet statement. They would begin totaling up all line items on the balance sheet, subtracting total liabilities (business expenses) from total assets (income). The resulting figure will be the total value of all tangible assets and a rough estimation of how much money you would net if you were to sell your business and all of its assets today.

The book value method is a great way to get a ballpark figure with minimal effort, but it’s not the most accurate way to perform a business valuation because it doesn’t account for all business aspects—note the exclusion of intangible assets in the calculation above. The lack of intangible assets and other factors means it does not provide a whole-picture view of the company’s present-day worth, just its book value.

Discounted Cash Flow

Discounted Cash Flow (DCF) determines a company’s value by creating a forecast of its future cash flow and converting that amount into present-day values by ‘discounting’ it to account for inflation. It’s most commonly used to evaluate newer companies that have a high potential for future growth but have yet to achieve profitability.

To use this valuation method, start by analyzing past company performance and current market trends to project what the cash flow will be in the future and how much current company assets will be worth at that time. Then, determine a discount rate. A common practice is to use the company’s Weighted Average Cost of Capital (WACC) or the current interest rate as the discount rate. Finally, calculate the business value using a financial calculator or manually solving the following formula:

Discounted Cash Flow = CF1(1 + R)1 + CF2(1 + R)2 + CFn(1 + R)n

Where:

CF1= The cash flow for year one

CF2= The cash flow for year two

CFn= The cash flow for additional years

r = The discount rate

The discounted cash flow method can help businesses see if projects will be worth their investment, but it should never be used in isolation to determine a business’s value because it uses estimates of future cash flow and doesn’t account for changing marketing conditions.

Market Capitalization

This valuation method is one of the simpler ways to calculate the market value of a publicly traded company. Simply take the current price of a company share and multiply it by the total number of shares. While this method can give you a good idea of what the value of the company’s equity is, it doesn’t account for debt. Since most companies operate on both debt and equity, market capitalization falls short of capturing the whole picture, but it’s still a useful way to quickly and easily get a sense of the company’s general worth.

Enterprise Value

The enterprise value method builds upon market capitalization by including both a company’s equity (market capitalization) and debt in its calculation. This valuation is performed using the following formula:

Enterprise Value = Debt + Equity – Cash

Enterprise value is a simple way to get a more holistic view of a company’s worth and also compare equity versus debt within its capital structures.

EBITDA

Some financial professionals prefer to use raw data in their valuation calculations rather than pre-calculated numbers like the total reported revenue or total net income. This is because factors like taxes and interest payments can skew the numbers to make a business look more profitable than it actually is. Similarly, typical accounting practices result in depreciation and amortization of assets over time, which, when left out of valuation calculations, can distort a growing company’s profitability measurements.

To avoid these complications, a company may choose to use the EBITDA valuation method—measuring total earnings before interest, taxes, deprecation, and amortization. An EBITDA valuation is done by adding each of the four categories to a company’s net profits as shown in the formula below:

EBITDA = Net Income + Taxes + Interest + Depreciation and Amortization

Present Value of a Growing Perpetuity Formula

Perpetuity is a term for assets that pay a return for an infinite period of time. While extremely rare in the real world, perpetuity is a common concept in finance and it can be used to calculate the present-day value of a company. The growing perpetuity formula assumes a company continues on forever but that its cash flows will increase from year to year at a consistent rate.

With that assumption, you can work backward to determine the current value of this future growth by dividing the total cash flow by a chosen discount rate. The discount rate should be carefully chosen to represent the riskiness of future cash flows and the expected rate of return based on current industry and market conditions.

Present Value of Growing Perpetuity = Cash Flow Discount Rate – Growth Rate

Times Revenue Method

The Times Revenue Method uses the amount of revenue earned in a previous period to estimate a potential range of future cash flows. The lowest value, known as the floor, is calculated by determining how much money the business could get for all of its current assets today. The highest value, known as the ceiling, is calculated by selecting a period of comparison (one of the most common companies use is the previous fiscal year) and multiplying the total revenue during that period by a specific multiplier. The multiplier will vary depending on the industry outlook and current market conditions. The floor and ceiling amounts help a business owner understand the potential range of prices that someone might pay to acquire their business, which can help nail down a good starting price for negotiations.

Earnings Multiplier

A company’s profits are often more telling than its reported sales revenue because it shows how much money the company is actually taking home. The earnings multiplier works by following the formula below:

Current Stock Price / Earnings per Share = # of Years to Make Back the Stock Price

The lower the number of years to make back the stock price, the higher the company earnings are and the greater its value. Businesses can perform this valuation retroactively to compare the company earnings now to prior years and also futuristically by using cash flow projections to calculate anticipated earnings per share.

Liquidation Value

The liquidation value of a company is a simple valuation technique that evaluates a business’s worth by calculating its net cash after a hypothetical closure event. Assuming the business went out of business today, you would tally up the sale of all tangible assets (liquidation) and subtract the total cost of paying off all of the business’s liabilities. The remaining amount is the company’s net worth. The higher the net worth, the greater the company value. It’s important to note that this method does not take into account intangible assets like intellectual property or the value of the brand itself, both of which would increase the business value if it were sold.

What is the rule of thumb for valuing a business?

If you’re looking for a shortcut to determining business value, then you can follow this valuation rule of thumb: a business’s value will always be a multiple of its annual EBITDA—earnings before interest, taxes, depreciation, and amortization. Most commonly, the value will fall into the range of two to six times the EBITDA. However, keep in mind that rules of thumb are nowhere near as thorough as other business valuation methods that take into account other factors like intangible assets, cost of capital, cash flow analysis, etc. Rather, it’s a simple way to get a ballpark idea of what a business might be worth.

Podium’s Business Calculator

If you’d like a quick estimate of your business’s fair market value, you may consider using a business valuation calculator. Podium’s Business Valuation Calculator is a free tool that simplifies the valuation process to give you insights into your company’s current financial health and ideas for improvement in the future without the cost or time constraints that come with using a certified business valuation expert.

The Business Valuation Calculator asks for only five key pieces of information: total revenue from last year, total cost to produce your goods and services, total overhead costs, total asset value, and the number of office employees. Using that information, the calculator crunches all of the numbers for you and provides you with your Total Gross Profit, EBITDA, and EBITDA percentage. Keep in mind that a business valuation calculator is only as accurate as the data you provide it with, and even then, its calculations are only an estimate of the business’s actual worth. If you’re planning to sell your business, an appraiser may require you to utilize a certified business valuation expert to arrive at a more accurate profitability estimate. However, these estimated numbers can help you better understand your current market position and guide you as you make informed decisions about how to scale your business in the future.

Start your business valuation now with Podium’s free Business Valuation Calculator!