Find out if you are creating a more valuable saleable asset
Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business.
The three main methods of valuing businesses are:
- Income approach – Calculated as the net present value of the discounted cash flow expected to be generated by the business in the future and the risk associated with the investment.
- Asset-based approach – This determines value by adding up the net value of each asset found on the business’s balance sheet. As intangible assets like internally generated goodwill are often not recorded on the balance sheet, then this method can undervalue a business.
- Market approach – Determines value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region. This method is based on the economic principle of competition but can be problematic where there are no similar companies sold.
The business owner needs to understand what valuation method is most appropriate for their type of business and what the critical factors that affect the valuation are. For example, accounting practices have mainly been valued based on the market approach with a sale price equal to one year’s fees revenue. So an accounting practice with $1 million in fees is valued at $1 million.
Annual business valuations are important to the business owner as it indicates to the owner whether they are creating a more valuable saleable asset, and if so, how much value was added over the last year.