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Valuing a Business: 7 Company Valuation Formulas Step-by-Step

basic business valuation formula

A solid understanding of these factors allows comparison of the subject company’s performance to the business valuation data of others in the same industry of similar size and age. In a previous article, we discussed some of the basics of business valuation—the “rules of thumb” most important in compiling an accurate valuation. In this article, we’ll examine all the important elements of business valuation from start to finish. Using a business valuation calculator is a fast and simple way to get a ballpark value of a business without hiring an expert and with minimal effort; however, it’s not without its disadvantages.

Consequently, only use this valuation formula if the comparison company is quite similar to the owner’s company. Several business valuation methods are based primarily on the market price for similar businesses at a given point in time. Business brokers and mergers and acquisition specialists are more likely to favor thesemethods, at least as benchmarks, since they have access to data about recent sales and merger activity. Ideally, market-based methods should be used in conjunction with an examination of earnings (historical or projected) so that they can serve as a «reality check.» The DCF method of business valuation is similar to the earnings multiplier.

Historical earnings methods are commonly used

Business valuation is the bread and butter of investment banks and M&A intermediaries. Anyone reading the valuation should be able to arrive at the same conclusion as the individual conducting the valuation based on the information provided. These methods are popular because they’re widely understood, but also because the underlying numbers are easier to obtain. More often than not,  valuation professionals seek to use a combination of these to arrive at an answer. And while you can add value to a transaction through a successful integration, paying the right price for a company gives you the best platform to do so.

In this formula, net income refers to the company’s profit after all expenses are paid, including taxes and interest. Depreciation and amortization are added back to account for the non-cash expenses that are subtracted from net income. In this formula, EBITDA stands for earnings before interest, basic business valuation formula taxes, depreciation, and amortization. The industry multiple and peer group multiple refer to the multiples used to value companies in the same industry or peer group as the company being valued. If your business is valued at $200k in assets and $50k in liabilities, your business is worth $150k.

Add Business Assets & Subtract Business Liabilities

It can also be used in appraising a business that’s being put up for sale, although the IRS does not prescribe it for this situation. The problem with either of these methods is that theyignore the fact that two businesses in the same industry with similarrevenues can have greatly different profitability margins, depending ontheir expenses. Next,multiply the annual free cash flow by the number of years theacquisition loan will run. From this amount, subtract the down payment.The remainder is the amount available to make interest and principalpayments on the loan, and to provide the new owner with some return oninvestment. This is probably the method mostcommonly used by small business purchasers, because few buyers are ableto purchase a business without taking out a loan. Consequently, theywant to be sure that the business will generate enough cash to pay theloan off within a short time, usually four to five years.

Business valuation is the practice of estimating how much a business is worth. It lets business owners who want to sell put a price on their businesses, and it helps potential buyers decide whether to make a purchase. Sales revenue apart, founders are required to raise funds either from investors or other money lending institutions. Alternatively, the company might be structured in a way that eventually leads it towards an acquisition or an IPO. Without accurate numbers, none of these economic transactions are possible, as the interested parties will not have any reference point to initiate discussions. The comparable sales method attempts to locate similar businesses that have recently sold in your area, and uses those comparable sales figures to set a price for your business, adjusting appropriately for differences.

Capitalization of Earnings Method

Our business valuation calculator doesn’t factor in tangible and intangible assets which can both significantly impact a business’s actual value. While you may pay more for a business in an industry with high multiples, it’s also more likely to hold its value. This means that when you’re ready to sell the business in the future you should still be able to get a higher sales price for it, especially if you choose an industry with high future growth potential. This means that your business is going to get the value that the market dictates based on your performance, the current economy, and the industry.

basic business valuation formula

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