Valuation Methods for Business: Which Valuation Method is Best for Your Business?

Often startups or businesses fail due to some unforeseen circumstances. It is at that time when the entrepreneurs think of selling their brand. Now here's where the business valuation process comes in. There are numerous ways through which one can decide the entire cost estimation or valuation of their own business.

Well, business valuation is often conducted due to numerous reasons and is not just limited to selling one's business. The entrepreneur might want to look for new investors in their business, and that might be another reason for opting for the business valuation process. This article discusses the various methods and benefits of business valuation.

What is business valuation all about?

Business valuation is the process of finding out a company's financial value. The process is conducted by professional evaluators who can bring out the exact value of your business by using various valuation methods and arrive at aggregate numbers. Let's move on to discuss the top 7 business valuation methods.

7 methods of business valuation

1. Return on investment or (ROI) valuation method

This kind of valuation method evaluates the company's value based on the profit and ROI an investor would receive for buying your business. Every investor, from a practical standpoint, wants to know the Return of Investment amount for a business they would be investing in, and this valuation method answers it all.

2. Asset-based valuation method

This kind of valuation approach considers the total net asset value of your business minus the value of the business as total liabilities as per your balance sheet. There are two ways of approaching the asset valuation method:

• Going Concern approach: In this kind of approach, a business has plans to continue operating and not immediately sell off its assets. The formula for this kind of approach is the business assets minus liabilities.
• Liquidation approach: The next is the liquidation approach, based on the assumption that if a particular business is doomed, its assets will get liquidated. In this approach, the value of a particular business asset decreases as the liquidation value often goes much less than the market value.

3. Market value valuation method

It is one of the most subjective approaches towards measuring a business’s value. In this type of method, the value of your business is compared to some other similar businesses that have been sold. This kind of approach is quite challenging for the sole proprietors because it is quite difficult to find the exact comparative data particularly on the sale of a similar business. Ultimately, this kind of valuation method is quite imprecise as the worth of your business will be ultimately based on market research value and negotiation if you are selling it or looking for an investor.

4. DCF or discounted cash flow valuation method

The DCF method is also known as the method of the income approach. In this type of approach, a business that is based on its estimated cash flow is discounted or adjusted to its present value. The DCF or the discounted cash flow valuation method is particularly utilised if the expected profits are not consistent in the present and won't be in the future as well.

5. Multiple of earning valuation method

The multiple of earnings valuation method mainly determines the value of a business by its potential of earning ROI in the future. This type of business valuation method is also known as the time revenue method. It mainly calculates the worth of a particular business by allotting a multiplier to the business' current revenue. These multipliers vary as per the economic climate, industry, and other factors.

6. Capitalisation of Earnings Valuation Method

In this method, people mainly calculate a future probability of a business based on its annual return, cash flow, and expected value. Unlike the DCF method, the capitalisation of earnings valuation method works best for stable businesses as its formula makes assumptions that the single-time calculation will continue. In this manner, this method takes on the current value of a business on its ability to be successful and profitable in the future.

7. Book Value Valuation Method

The book value valuation method measures and calculates your business’s value by looking at your balance sheet. Your balance sheet will be used for calculating the equity value of your business for the total assets by subtracting it from the total liabilities. The result value will represent your business’s worth. For small businesses or those businesses which have low profits, the book value approach is extremely useful.

Reasons to go for business valuation services

Business valuation services are required to check the complexity and what of a particular business. Here are a handful of reasons why entrepreneurs and business owners need to evaluate their company's worth:

• While Looking Forward To Acquiring Another Company Or Merging With An Existing One
• While Looking Forward To Selling Their Business
• While Looking Forward To Investors For Business Financing
• While Adding Shareholders
• For Certain Taxation Purposes
• For Personal Issues Like Broken Partnerships Or Diverse Proceedings.

Several factors determine why the valuation method is required. It involves the size of your business, the type of market you are dealing with, your industry, and so on.

How frequently should an entrepreneur go for a business valuation?

The business valuation method may be conducted at different points of time for various reasons. Often it is related to exit planning strategy, investment decisions, a potential buyout or sale, or an impending IPO. Because of numerous reasons, it is always recommended to go for hiring the best and reputable valuation services that can come up with the appropriate result that can justify your business worth. Although nobody can be sure about the frequency of conducting the business valuation method, here are a few approaches for this process.

• Never or very rarely: For small businesses which do not seek to sell their business or go for capital infusions, it may be possible for them to avoid the evaluation process altogether. However, a few entrepreneurs often require doing this business valuation method. This kind of small business can go through the valuation process every 5 to 10 years.
• Annually or once every two years: Several other businesses engage themselves in high financing capitalisation, and high volume investing regularly. These kinds of companies need to go for a regular business valuation method every one or two years as needed. Obtaining this kind of occasional business valuation for such companies would be more than enough. Also, with the changing economic landscape going for the business valuation process annually or once every two years will be accurate.
• On a regular basis: The business valuation method is frequently conducted by large companies or MNCs who engage themselves in high transaction and high stakes. However, these companies don't need to outsource such services as they have a team of business valuation experts.

Wrapping it up

The business valuation method has a wide range of utilisation as it plays a crucial role in various strategic business decisions, especially while going for expansion, acquiring loans, and mergers and acquisitions. Choose any one method very carefully as a wrong choice can lead to financial losses to your business in the future. Also, if you are looking forward to finding the best business valuation model for your business, it is always suggestible to study the methods properly and determine which will be the appropriate one for your business. You can also combine multiple business valuation methods for evaluating the value of your company.

Also read:

1) Best Tips for Customer Retention for a Small Business
2) Tips to Understand Your Market while Starting a Small Business
3) Tips for Businesses to Overcome the Covid Blues - Revival Tips for Businesses
4) What are the keys to success when operating a small scale business?
5) OkCredit: All you need to know about OkCredit & how it works.

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FAQs

Q. What type of businesses can go for the business valuation process?

Ans. Any small, mid-sized, and large business can go for conducting the business valuation process.

Q. What is a VDR, and how does it help in business valuation?

Ans. A VDR, also known as a virtual data room, is a secure online database utilised for sharing confidential information related to financial transactions. By adopting VDR, companies can expedite their business valuation process.

Q. Is it possible to do a business valuation on a system of 64 bit?

Ans. Absolutely. You can also run the business valuation analysis on both 32 and 64 Bit systems.