How to Decide the Valuation of Your Small Business?

Have you just started your business and are struggling with how to evaluate its worth and value fairly? Have you ever thought about how to easily calculate your small business’s worth in cash single-handedly or without any help from a financial expert or CA's? Worry not; we have a list of the most effective and easiest ways to calculate your business’s net worth. There are several ways by which you can quickly evaluate the value of your small business. This method gives the insight to provide a fair idea of effectively calculating the company’s net cost.

The Three Methods for Small Business Valuation

1.  Asset-based valuation approach

The asset-based valuation method focuses on your small business’s assets and liabilities. In this method, you focus on summing up the total values of assets and subtracting any debts or liabilities involved. Initially, it is essential to find out the difference between the assets and liabilities. Assets are the profit or income made by your business, or, you can say, all the parts of your business that add value to your small business. Liabilities are those parts of your business that add debts to it. In simpler words, liabilities are simply the loans or the business’s debts that the company owes to the credit owner or company. When using an asset-based valuation method to evaluate your small business, you just need to follow a simple calculation. Calculate all the smallest to the most significant part of your business that adds value to it and then calculates all your company’s debts or liabilities to the different creditors.

Once you figure out the total asset and liabilities, subtract your business’s total debts with your asset’s total value. It will result from the actual book value of your small business in the market. Book value is the real net worth of any business. For instance, if you have 5,00,000 INR in assets and 30,000 INR in liabilities, your business’s value is 4,70,000 INR (5,00,000 INR – 30,000 INR = 4,70,000 INR). So, using an asset-based valuation approach, you will be able to find the net worth of your small business with the help of assets and liabilities.

2.  Market-based valuation approach

The market-based valuation method focuses on your small business’s market presence concerning the competitors or similar business market worth. In this method, you compare your business with other similar companies or the competitor’s business. In this approach, you have to find or spot those businesses with similar domains as your business and run with matching sets of tangible and intangible assets. The market-based valuation approach is further divided into two valuation methods or approaches – public company comparable & precedent transactions.

• Public company comparable – The public company comparable valuation method works well for publicly traded companies to evaluate their worth using valuation metrics that are considered likely with the subject entity. During many observations, using direct comparability for companies’ valuation is hard to maintain for large public companies and is not similar to the subject. The direct comparable is preferred and works well with the small companies.
• Precedent transactions – The precedent transactions method workaround was calculating and finding value with pricing multiples. By observing and considering all the companies’ transactions in the subject company’s market, you can easily calculate the precedent transactions. The precedent transaction method’s basis is that the financial data and information comprehensive company are not available or is harder to trace the financial records. Still, the transaction value of the extensive company is available for the calculation and the valuation process.

3. Income-based valuation approach

The income-based valuation method focuses on your small business’s financial condition. The income approach to short business valuation determines the total amount of expected income a company can generate in the coming or near future. Suppose you wish to follow the income-based approach for valuing your small business; in that case, you can pick or select between two commonly used income-based valuation methods – discounted cash flow method & capitalisation of earnings method.

• Discounted cash flow approach – The discounted cash flow method is a type of income-based valuation, calculating the business’s present or current worth with future cash flow. The business’s future cash flow is maintained or taken into account by including the risk involved while purchasing it. The discounted cash flow approach is more preferred and works fine with a growing or more recent business with high-growth potential but is not profitable yet.
• The capitalisation of earnings approach – Using the capitalisation of earning method results to calculate the business future scope of profit earnings by considering and monitoring the business cash flow, the expected values or estimate of the small business, the annual rate of return ROI. The discounted cash flow method credits for more fluctuations in a whole cycle of the business’s financial future. This valuation approach assumes that the calculation made for a single year or period followed in the near or coming future. The earnings method’s capitalisation is more preferred and works fine with established companies with stable profitability in terms of financial state.

The income-based approach is carried and followed well if you have more information or financial information details. You can then follow a more comprehensive income-based valuation tool that considers factors such as – revenue and profit, assets, and liability. After considering the stated valuation methods, it would be easier for you to figure out how you can effectively choose your small business valuation method. It would be best if you considered some vital key points to determine your small business’s value.

Some Factors to Determine the Value of Your Small Business

Deciding your small business valuation is an excellent approach to finding out the net worth of your business. You will also be aware of its financial health and risk potentials of your business. By following and doing the financial calculations and handling all the financial dealings, valuing your business also needs you to know your actual worth in the competitive market. It is a very effective method. Suppose the company you're evaluating is your first one or is carrying your family business legacy. In that case, the valuating approach is valuable for taking care of the valuation in the most objective possible way.

1.  Understanding the need for valuation and valuation process

Knowing and understanding your business's financial health is essential to track and plan your small business’s growth. If you are not a finance-related person, you need to understand the need and the different valuation process modes.

2.  Researching and understanding your industry

Before touching your small business’s valuation process, it is equally crucial to understand your industry’s nature. Knowing your industry's ins and outs will help you understand the nature of your business well. It will also help you find out your small business’s informed valuation to reflect your current market’s business assets and trends.

3.  Managing and maintaining your finances

Before initiating your small business's valuation process, it is indispensable to streamline te finances' records and information to make it easier for the valuation method. So, always keep your financial documents for an accurate valuation of your small business.

4.  Handling and taking account of your assets

The best way to evaluate the valuation process is to use your resources and make the most of them. To follow that, you can make a list of all the assets such as intellectual properties, employees, debts, stocks, cash, investments, expenses, profits, and liabilities for taking account of your assets. Further, the list will help you carefully determine your small business’s accurate and most recent value as per the current market.

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3) Hiring and Managing People Wisely: HR Mantras For Small Businesses
4) How to get your business listed on the Stock Exchange?