How to Value a Business

How to value a business with an outline of business valuation development and business valuation methodology including a return on investment (ROI) business valuation calculation example. It considers the benefits of valuing a business for business buyers, business sellers and its value in business negotiations. Specific business valuation software user feedback and comments are also provided to assist business valuation assessment and help you determine the benefits of using bizpep's business valuation application to value any business.

The original Business Valuation Model Excel was developed and released in the late 1990's by bizpep. The concepts and methodology applied introduced a new paradigm in how a business valuation could be approached. Since its original release it has been widely copied and initiators have attempted to capture referrals by closely linking the names of their copied products to the keywords Business, Valuation, Model, Excel.

The current Business Valuation Model is essentially the same as the original and developed with the same methodology. It is this methodology that is the underlying strength and value of the valuation.

The methodology applies relative indicators for future performance allowing a forecast business surplus to be determined based on the changing business environment. It also provides sensitivity analysis to assess the range of forecasts (optimistic to pessimistic) and applies these to calculate a business valuation. Using a business forecast that considers the dynamic environment in which the business operates is the basis of a verifiable business valuation. Applying Sensitivity Analysis allows a range of scenarios and corresponding valuations to be analyzed.

Over the years substantial user feedback has been received, a strong understanding of the issues relating to business valuation developed, and a range of business valuation information identified.

What is a Business Valuation?

A Business Valuation is a calculation of the value of a business. This value is effectively the price a business could sell for or the maximum amount of capital that should be expended in setting up a business. A Business Valuation should provide a realistic and justifiable value of a business. This value represents the level of investment in a business that will provide an acceptable return. In practical terms this is the purchase / sales price of a business or the maximum amount of capital applied in business establishment.

Return on Investment Business Valuation

The price paid for a business should be related to the investment return the business provides. A business is basically an asset that generates income and profit. The value of the business is determined by the required return on investment.

Business Valuation Calculation using Return on Investment

If the business generates $100 of profit per annum and the required return on investment is 10% per annum then the price of the business that provides this return is $1000.

Business Valuation = Profit p.a. / Return on Investment p.a.

$1,000 = $100 / .10

It is future profit that is the key determinate in this equation, the higher the forecast profit the higher the business valuation. Developing a solid forecast based on the macro and micro business drivers is important. This will also allow a risk assessment to be made which will impact the required return on investment. The higher the perceived risk the higher the required return on investment and the lower the business valuation.

Do I need a Business Valuation?

Yes... if you are buying or selling a business you need to independently determine the business value. Establishing a valid understandable and independent business valuation is important it:

• Allows you to form your own independent assessment of the business without relying on the analysis of others.
• Highlights the businesses current financial performance.
• Forecasts the future business financial performance from current basic numbers.
• Allows business potential to be identified in financial projections.
• Acts as a quantifier of business risk and in turn required return on investment.
• Enables a comparison to be made between new business establishment and buying an existing business.
• Provides Sensitivity Analysis to determine a business valuation range based on optimistic to pessimistic financial forecasts.
• Allows interactivity and the ability to play with a range of what if scenarios.
• Promotes active consideration of internal and external business drivers and the identification of both business opportunities and threats.
• Enables the display of a business financial forecast and associated business valuation for comparison with other projections and valuations.
• Allows validation and testing of financial data provided by others.
• Applies basic numbers Revenue, Variable and Fixed Costs to assess real business performance.
• Allows you to test forecast variations to determine the impact on business financial performance.
• Allows you to incorporate specific skills / ideas / expertise into business forecasts to assess the business potential based on the value-adding they can apply.
• Enables a comparison to be made between different investment options.
• Provides a strong negotiation tool in determining a final business value and price paid.

Can Software Value a Business?

Can a business valuation be developed using valuation software? There are some valuers that would say no. But perhaps the best answer to this comes from software user feedback:

Can Software Value a Business? Based on the feedback the answer is Yes.

Business Valuation Methods

Business Valuation methods include Industry Multiples (ie revenue times a multiple), past market prices, asset based valuations, and a range of return on investment approaches.

Business sales people tend to focus on industry multipliers i.e. some number multiplied by annual sales revenue. The multiplier basis really is a very generalized approach to business valuation where businesses within industry groups are lumped together and a multiplier applied that will on average for that industry provide an broad indicative valuation. However it is of no use in identifying businesses that offer potential looking forward and hence is a very poor business valuation approach.

When considering the business return (profit) as an income stream from an investment (the amount invested in the business) the Return on Investment approach is most suited and widely applied. This approach considers the specific business performance. Using the Return on Investment approach requires a business forecast to determine future business returns. If this forecast applies market knowledge and allows business potential to be quantified a solid basis for valuation is provided.

Revenue, Variable and Fixed Costs of a business provide the underlying financial relationships of a business. These allow you to project profits for varying revenues and build forecasts to assess future performance and business value. It is the basic financial numbers and your ability to gain knowledge from them that count. Accounting standards can hide the real information. Basic numbers can tell you a lot.

Business Valuation for Sellers

Value of a Business Valuation for Sellers:

1. Highlights the businesses current financial performance.
2. Forecasts the future business financial performance.
3. Allows business potential to be highlighted/demonstrated in financial projections.
4. Acts as a quantifier of business risk and in turn required return on investment. The higher the risk the higher the required return on investment.
5. Provides Sensitivity Analysis to determine a business valuation range based on optimistic to pessimistic financial forecasts.
6. Allows interactivity and the ability to play with a range of what if scenarios.
7. Promotes active consideration of internal and external business drivers and the identification of both business opportunities and threats.
8. Enables the display and explanation of a business financial forecast and associated business valuation to prospective buyers.
9. Allows sellers to test forecast variations to determine the impact on business financial performance.
10. Provides a strong negotiation tool in determining a final business sale price.

Business Valuation for Buyers

Value of a Business Valuation for Buyers:

1. Allows validation and testing of financial data provided by sellers.
2. Applies basic numbers Revenue, Variable and Fixed Costs to assess real business performance.
3. Forecasts the future business financial performance from current basic numbers.
4. Allows prospective business buyers to test forecast variations to determine the impact on business financial performance.
5. Allows the buyer to incorporate specific skills / ideas / expertise into business forecasts to assess the business potential based on the value-adding they can apply.
6. Enables direct comparison of alternative businesses.
7. Provides a strong negotiation tool in determining a final business purchase price.

Business Valuation for Negotiation

In essence a business valuation is the amount of money that can be invested in a business while ensuring the required return on investment is achieved. The return on investment is determined from the business surplus and the amount of investment i.e. purchase / sale price. The required return value is influenced by the business risk and the opportunity cost of investing in the business. As the business price is the variable under negotiation and the opportunity cost can not be influenced there are only two negotiable variables left....

From a sellers negotiation perspective:

• Demonstrate an increase in the business surplus and the price can be negotiated upwards.
• Demonstrate a decrease in business risk and the price can be negotiated upwards.

From a buyer negotiation perspective the reverse is true:

• Demonstrate a decrease in the business surplus and the price can be negotiated downwards.
• Demonstrate an increase in business risk and the price can be negotiated downwards.

A forward looking Business Valuation provides a key negotiating tool for both buyers and sellers. It provides the underlying logic for the investment decision.

Business Valuation Video

This video provides a quick overview of the business valuation methodology and approach applied in Business Valuation

See how to value your business with our Quick Business Valuation Overview Video

Value your Business Now

You can download Business Valuation now and easily value your business.