If there is one thing that is important to evaluate when looking at your business, it’s judging how much your business is worth. From garnering investors to getting insurance to selling your business down the line, it is vital to consistently monitor the health of your business based on its valuation.
Often times in personal and professional realms, people do not know the worth of what they have. From priceless paintings bought at yard sales to the recent over-valuation of many, many startup companies which are now struggling, knowing the true worth of the business you’ve built is a key component to keeping it thriving.
There are several ways you can determine that value of your business, and there are accountants and professional business valuation experts that can walk you through the process. But before you start paying a professional, it’s important to have an understanding and a baseline that you have determined on your own.
Discounted cash flow is the best method of valuation, and the most often used to come up with the “fair value” for a company. To describe it as simply as possible, because it is a deeply complex system, discounted cash flow tries to determine the value of a company right now, today, based on projections of how much money it is going to make in the future. This method of analysis says that a company is worth all of the cash that may be made for investors or owners in the future. The reason for the word “discounted” in this method is the belief that cash in the future is less valuable than cash in your pocket, right now.
From Investopedia: “For example, let’s say someone asked you to choose between receiving $100 today and receiving $100 in a year. Chances are you would take the money today, knowing that you could invest that $100 now and have more than $100 in a year’s time. If you turn that thinking on its head, you are saying that the amount that you’d have in one year is worth $100 dollars today – or the discounted value is $100. Make the same calculation for all the cash you expect a company to produce in the future and you have a good measure of the company’s value.”
This will vary from industry-to-industry, as physician’s offices and accounting firms are often placed at the value of one year of annual revenue, whereas software companies can be valued at up to five times the annual revenue. Banks are valued at up to twenty five times the annual earnings. Since some of this is managed by the market, it is important to do some research to see what your discounted cash flow is compared to the valuation of similar businesses.
You can also use an asset-based approach to value your business, which would look at property, inventory, customer base, cash-on-hand, and the brand that you have built. Putting a dollar number on a brand is difficult, but often can be a big determining value. For example, a corner market bodega with no branding has very little value here, whereas a branded Italian market on the same corner where care has been taken to develop a typeface, logo, decor inside, a well-curated stock of goods (even if they are of the same inventory value of the bodega) that adhere to the brand identity, and a loyal customer base who associate this brand with quality, will have many of the same assets as the bodega grocer with a much higher valuation. Often, assets based accounting of business value is more useful to those that have more assets than revenue (i.e. real estate developers).