As an entrepreneur, recognizing the worth of your business is incredibly important. This is because your business no matter how small it might be is one of your significant assets. Besides that, being always aware of how valuable your business makes it easy for you to make urgent decisions.
For instance, you might need to make an urgent exit, and if you are aware of the value of your small or medium-sized entity, then your succession process will be exceptionally smooth sailing as you will get what you deserve and be merry on your way. There are plenty of other reasons why you should ensure your business undergoes valuation every year. We have outlined them below, as well as the various techniques used in business valuation.
What Exactly Does Business Valuation Mean?
To put it simply, a business valuation refers to the procedures and processes that help determine the economic worth of an entity. Most companies carry out an assessment every year for various purposes the primary one being to determine the value of the entity. A small business valuation is also highly significant as it allows the entrepreneur to decide whether the business is experiencing growth, stagnation or a decline.
Other common reasons why businesses conduct valuations are as follows
– For exit or retirement strategy planning
– To evaluate the value of an offer placed by an investor interested in buying the business and negotiate the sale hence coming up with a price that is acceptable to both parties.
– To determine the capital gain
– For conflict resolution among shareholders or partners.
– To justify the annual per share value of ESOP
– To value a business while it’s undergoing a bankruptcy process
– For the equitable division of assets during a marital dissolution
– For mergers and acquisitions
Even though there are myriad other reasons why entities carry out business valuations, the above are the most common. Now that you are aware why this process is of the essence, below are the various methods used to determine the worth of a business.
In this approach, your appraiser, or the company you’ve hired to conduct the valuation usually takes all your assets into account and deducts the liabilities. In other words, the appraiser adds all receivables, for instance, cash, property, stock, equipment and any other assets that are under the business name together, and then deducts liabilities, such as bank debts from the total. What remains is termed as the net asset value and is also your business’s value.
Income Approach and Market Approach
As the name suggests, this methodology determines the value of a business based on its income. This approach focuses on discretionary and net cash flow and additionally the capitalization of earnings. In this approach, the appraiser determines the economic worth of an entity by comparing it to businesses that are similar to your which have undergone a recent sale. However, it is effective if there are many businesses in the same realm as you.