Most small companies have money going in and out, making it hard to determine an accurate business valuation. Reasons you might need to know its worth include information to apply for loans or ensure you’re succeeding.
Figuring the value of your company can be simple or complex. If you run a service business, knowing what contracts you have, the cost of supplies and staff makes the number-crunching simple. However, you must also count stock and predict future sales figures if you sell inventory.
In addition to figuring out the details you need for your purposes, you’ll also tap into the power of different types of valuations. Here are the things to consider and the possibilities for a business valuation.
Types of Valuation
Coming up with a business valuation requires looking at inputs that apply to your brand. Companies that are detailed in their valuations find more success via their final numbers. You’ll get more information by looking at things like return on investment (ROI) valuation.
If you spend X dollars on advertising, you might consider how many new customers you can expect and what each is worth. At other times, you may need to know your assets’ net worth or value if you were to liquidate today.
Seller’s Discretionary Earnings (SDE)
Many small-business owners pull out a percentage of earnings for living expenses. When determining the worth of your brand, you must factor in your SDE. The person looking to buy your company or a bank considering a loan will want to know that you are making enough to live comfortably. Some entrepreneurs pour all their earnings back into their company, which can make it look like it’s growing rapidly even though it isn’t turning enough of a profit to sustain even one employee.
Figure out your SDE to determine how successful the brand truly is. Add all gross earnings, subtract costs and value all major expenses. You also must factor in liabilities of current debts and upcoming payments.
IRS Method
When companies change hands, such as during an estate settlement or a sale, the IRS requires the evaluation be conducted in a certain way. Companies may want to hire a specialist to ensure the valuation adheres to the IRS’s guidelines. For example, a professional appraiser will typically review three to five years of historical financial data.
Follow the Internal Revenue Manual 4.48.4. Identify and describe all properties, and hire a qualified appraiser to value the business. It is well worth the expense and will ensure you’re being compliant with all requirements.
Market Valuation
One of the simplest business valuation techniques is market-based. If your brand has shares, you’ll calculate the price by the total number. Examples include corporations such as Amazon, worth an estimated $299.28 billion, and Apple, worth $297.51 billion.
Small brands aren’t likely to see those numbers but may have shares they’ve provided to employees, investors and other stakeholders. Tracking and adding them up is vital to correctly calculate your company’s worth. Get help from a professional if necessary to ensure accuracy.
Multiply Revenue
Knowing how much revenue comes in helps you establish the worth of your company. Use the times revenue method to quickly review your company’s health. You can spot and fix ROI weaknesses before they cause you to bleed money. Take your different revenue streams over a period of time (quarterly, annually) and add them up.
As a rule of thumb, you can multiply the number three times to get an idea of your company’s worth. Knowing the base number also ensures you’re bringing in enough money to cover expenses and still turn a profit.
Many companies run into trouble when they start growing. They have more expenses than money coming in. Multiplying revenue shows where your business will grow and if you can sustain the numbers or need more cash flow.
Immeasurable Valuation
Determining the health of your company isn’t always about crunching numbers. Unseen factors can impact your growth and long-term profitability. For example, how you recruit and retain your top employees can make a difference in future success.
Experts estimate it costs around $5,000 to hire a new employee. However, the money lost in resignations and finding and training replacements may actually be much more. You’ll lose experience and momentum. Each time someone leaves and a new worker comes in, the company culture changes a bit for the better or the worse.
Write out how long your staff stays with you. What is the industry standard? Is there anything you can do differently to keep employees with you for longer or permanently? Look for ways to improve your value that aren’t measurable and impact revenue.
Liquidation Value
What are your company’s tangible assets? If you had to sell off every item in stock and your equipment, what value would they bring?
Figuring liquidation value isn’t as common as some other methods but may be necessary at times. For example, you might need to know the number in case of bankruptcy. Knowing the final figures can help you decide whether to file or sell your assets to pay debt.
Book Value
The median value of U.S. companies before IPO valuation was $161 million in 2022. Of course, businesses come in all sizes — from solopreneur operations making $10,000 yearly as a side hustle to multi-million dollar corporations.
Book valuation can provide a quick look at the value of your brand’s worth. The formula is the company’s total assets minus liabilities. You may combine several types of valuations for your final number or gather asset worth to see how much you’d get in liquidation. The goal is to come up with the brand’s net worth.
A company with $300,000 in assets and $150,000 in liabilities is worth $150,000. You might use book valuation for investors to evaluate a company. Utilize it as an internal comparison to competitors, to figure out stock prices or to see the overall health of your company at a glance.
Choosing the Right Type of Business Valuation
Throughout the life of your company, you’ll use different valuations for various purposes. You might use book valuation to attract investors. At other times, you may need to know the base numbers of your assets’ value or see if you should declare bankruptcy.
In a perfect world, your business will thrive from day one, and you’ll only need to know numbers for future growth and planning. However, being aware of the possibilities gives you more flexibility and helps you keep a handle on your brand’s worth. That way, you can move forward no matter what external influences impact your business.