| Business Valuation |
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This briefing provides an insight into the basis and scope relating to the valuation of a business. The scope is not limited and will vary according to the needs of the purchaser and the seller and the type of business and industry in which it operates.
Valuing a business is carried out for a variety of reasons. You may be buying or selling a business or wanting to raise additional loan or equity capital, create incentives for employees or simply use it as a performance measure of management.
The valuation of a business is not an exacting science. It is objective in part whereby financial calculations can be made from official or unofficial company data, and subjective whereby a wide range of issues need to be considered. The aim of any valuation is to establish a fair market price because the end game is a price that a purchaser is prepared to pay for it and this includes those values, which are personal to any prospective purchaser. These may be emotional, status and lifestyle as well as the traditional objectives of investment and profit.
Any business owner is usually concerned with how much the business is worth and how its value can be increased.
So what do we need to know ?
The initial focus should be on the tangible and objective elements of the business such as:
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Audited Financial Accounts. |
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Current management accounts - past history and profit trends. |
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Premises - location, size, condition, owned, leased, length of lease. space adequacy and utilisation. |
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Systems, procedures, technology. |
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Equipment condition. |
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Number of years in operation. |
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Type of business - sole trader, partnership, company etc. |
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Followed by the intangible and subjective elements:
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Culture of the business. |
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General observation. |
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Reasons for sale, urgency. |
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Goodwill (Intangible assets). |
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Reputation and credibility in the industry. |
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Competitive position. |
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Create a profit figure that is relevant to you.
It is essential to gain a clear picture of the business entity separately from those of the owner. So separate personal and private items from the accounts and apply those which are relevant to you. Include your own cost adjustments, focussing on the areas in which you can be more prudent and economic.
Buying a business as a Going Concern..
If an investor is intending to buy a business as a going concern, then the purchase will include all aspects of the business, assets and liabilities. But the investor may by negotiation adjust or eliminate some elements if he considers them to be undesirable for business intentions. Eg an investor may not want to purchase the liabilities or the goodwill as they may be considered too risky or overstated respectively.
Valuation techniques
There are several valuation methods and at least 2 of these should be utilised for comparative purposes.
Asset valuation - this is simply the net assets (Total Assets - Total Liabilities), which is the same as the owners equity on the balance sheet. This is the overall Net Book Value (NBV) of the business.
Look closely at the NBV for each asset and determine how accurate it is respect of changes in value on the open market: eg land, buildings, machinery, unsaleable or obsolete stock, realisation of debtors and provision for bad debts etc. Intangible items such as good will, software development which may have been capitalised, patents, trade marks and intellectual property. But it may be appropriate to include certain items according to the future potential of selling on or increasing their value. The real issue is the reasonability of the value of any intangible asset.
Note: This approach does not take into account the potential of future earnings.
When to use - where the organisation has a strong asset base and is considered stable, ask such questions as:
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What is the original cost? |
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How do you increase its value? |
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What determines its value? |
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What is the future profit potential? |
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What are the asset values? |
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What is your business worth? |
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Other areas include:
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Discounted Cashflow |
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Value in Use (present value of future cash flows) |
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Price Earnings Ratio. |
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In financial terms, the formula to calculate the Price Earnings ratio (PE) is twofold
A) Calculate the Earnings per Common Share
Formula: Net Income -Preferred Dividends divided by the
No of Common Shares Outstanding
B) Then calculate the Price Earnings ratio (PE)
Formula: Market price per Common Share divided by the Earnings per Common Share.
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The market price (stock or share price) for publicly listed companies is driven by the Stock Exchanges and is readily available in financial sections of major newspapers and specific publications
Publicly Listed Companies & Non-Listed Companies
Rules of Thumb - Applying a factor or Price Earnings (PE) ratio and multiplying this by the Net Profit After Tax (NPAT) is often applied. This is considered widely inaccurate unless the NPAT figures are representative of the industry median and the source of the factor or PE ratio is reliable
But other factors other than profit are usually applied. The circumstance surrounding the reasons for selling or buying will depend on the nature of both parties.
The purchaser may be seeking growth by acquisition and in doing so a non profitable business could integrate with a similar business to gain economies of scale and reduced costs thus creating a potentially profitable environment. The benefit be to gain access to a wider distribution network.
The seller may have created the business and now seeks only to maintain the status quo because having built the business, a social responsibility and material benefits other than dividends, satisfy the owner.
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