Find out how to value your small business with the help of our small business accountants.
There are many reasons why a small business owner may wish to know the true monetary value of their business. Among them, putting a business up for sale, attracting investors and valuing shares for tax purposes are the three most common reasons.
In London, opportunities abound when it comes to selling or buying small businesses. Accordingly, many small business owners want to know how to value their business so they can set a maximum selling price accordingly. On the other hand, many entrepreneurs who are ready to capitalise on an established business also want to know the true value of a business to make sure they do not overpay.
At Tax Agility, our small business accountants are fortunate to work with parties from both sides in various transactions and experience the dynamics first-hand. We assist small business owners who want to sell, while in other cases we also advise entrepreneurs who want to buy a business and expand. In this article, we will focus on business valuation, in particular:
- What information is used in a business valuable
- Different valuation methods
What information is used in a business valuable
A client once told us that he had been advised that the most cost-effective way to value a business is to get an accountant to review the financial figures and then place a price on the business. Essentially, he was told to avoid formal valuables as they are expensive and buyers would likely make their own assessment anyway.
He was mostly right in the sense that accountants and financial figures are key when it comes to valuing a business, but the most important part is actually getting a qualified accountant who can take time to understand your small business and the full breadth of its operations. In other words, you need an accountant who can spend time to understand your management policy, the industry and the competitive landscape, along with financial statements. Ideally, the accountant should also help you to improve the value of your business before placing a price that truly reflects the worthiness of your business.
To give you an idea, here are the seven essential aspects a good accountant should take into consideration when valuing your business:
- Financial information – present and historical financial statements will be required to address a host of concerns. Profitability and cash flow, liabilities and assets, stock value and book value are among the many items which will be examined in great detail.
- Intangible assets – intellectual property, copyrights, brand recognition, and other non-physical assets will also be reviewed carefully.
- Management – finding out if the business has a dedicated team and is not over-dependent on key staff.
- Legal information – anything from compliance to any present legal proceedings against the company or the company is pursuing.
- Competition – market share, competitors, barriers to entry, other similar businesses on the market and other economic factors which can impact the business will be analysed.
- Future outlook – as business landscape evolves, the company’s short-term and long-term outlook will be scrutinised.
- Circumstances surrounding the valuation – if you are looking for a quick exit due to changes in life goals, then the perceived value is likely to be reduced.
Different valuation methods
When it comes to valuation a business, private companies aren’t listed on a public stock exchange and therefore, finding the value requires some work. Here are some of the common valuation methods used in London and the UK.
1. Earnings multiples
Earnings multiples determine a business’s ability to generate profits and use the figure to set the selling price. This formula is largely based on an industry-based average. For example, if your business makes post-tax profits of £200,000 and the industry-based average ratio is 3, then your selling price could be £200,000 x 3 = £600,000.
It must be said that there is no ‘fixed’ average ratio. It depends on the industry you are in (some industries have a higher average ratio than others) and the complexity of your products and services. Having said that, this method is common for valuing a small business that has been around and making profits for a number of years.
2. Discounted cash flow
Discounted cash flow looks at the estimated profits a business will generate and the likely value of the business at the end of as assessment.
The concept of discounted cash flow assumes that money is worth less in the future and it is today, after interest and inflation rates. To make this formula work, usually data from your past financial statements will be used to predict the future income.
This method is most appropriate for a mature business with a strong client base. It also works well for a business launching a new product with excellent future prospects.
3. Asset-based valuation
Asset-based valuation refers to the value of assets after subtracting business liabilities, without taking into account your business’s future earnings.
This method is most appropriate for a business with substantial tangible assets like property and machinery, as well as intangible but valuable assets like patents, goodwill, copyright, intellectual property, brand recognition and customer lists.
Apart from goodwill which is generally based on the calculation of a residual value, intangible assets are hard to value and a good accountant should use a number of established formulas which may include:
- relief from royalty
- excess earnings
- incremental income
- comparable transactions
- replacement cost
4. Entry cost
Entry cost is the estimated cost a buyer would have to invest to set-up a similar business. This formula tends to include:
- Employee recruitment and training
- Upfront asset costs and continued maintenance
- Product development (research and development)
- The cost of establishing a business’s reputation and its customer base
Which method you should use depends on your circumstances. Most small business owners offload this valuable process to a capable small business accountant.
Tax Agility can help to value your business
At Tax Agility, we look after our clients who are small business owners in London, Putney and Richmond. While we assist clients with the day-to-day tax and accounting work, our ultimate goal is to increase the value of your business by identifying its growth prospects. This way, when you are ready to value and sell your business, you will be cashing in on your reputable business and its success.
If you’d like, our small business consultants can work closely with you to take your business to the next level. We do this by reviewing:
- Annual business plans, forecasts, and projections
- Management accounting complete with regular overview information
- Review of credit control and cash flow
- Attend important business meetings
- Strategic plans for business acquisitions and disposals
- Advice pertaining to capital structure and business valuations
If you liked this article, you might also like:
- Planning the future of your business
- The complete guide to buying a small business
- How to find a good accountant in London
This blog is a general summary. It should not replace professional advice tailored to your specific circumstance.