A business valuation is the process of determining the economic value of a business, often used to establish its Fair Market Value (FMV). During this process, every area of the business is looked at to determine its worth.
FMV is the amount at which a business would be transferred between a willing buyer and seller, when neither is acting under pressure and when both have a reasonable understanding of the relevant facts. In this article, we’ll discuss the basics of business valuation and the factors involved in determining FMV.
Methods of Valuation
There are different methods of business valuation, such as:
- Book value – Calculated using information from your business’ balance sheet. Book value is determined by subtracting the total liabilities of your business from its total assets.
- Discounted Cash Flows (DCF) – Estimating a business’ value based on the money, or cash flows, it’s projected to generate in the future.
- Market capitalization – Calculated by multiplying the company’s total number of shares by its current share price.
For more information, check out How to Value a Company: 6 Methods and Examples.
Factors that Impact Valuation
FMV is the most common standard used when valuing a business. Many factors are considered when determining this price, including:
- Profitability – Assessing your earnings, cash flow trends, variability, and forecasts.
- Market knowledge – Understanding the trends and developments specific to the industry the business is part of.
- Marketability – How much have similar businesses sold for? Be mindful of supply and demand considerations in the business transaction marketplace.
- Assets and liabilities – Evaluating your business’ tangible and intangible assets.
- Barriers to entry – How easy is it for new competitors to enter the market?
The Business Valuator
When you’re choosing a valuator, consider these questions:
- What are their credentials and training?
- How much of their time and resources are devoted to business valuation?
- How long have they been performing valuations?
- Does the valuator work alone or as part of a team?
- How much will it cost? And, is there any commitment on the business owner’s part as it relates to listing the business for sale with the valuator?
Most businesses get a professional to do their business valuation. Having a third party complete the valuation ensures objectivity and accuracy throughout the process. Read BDC’s article, How to choose a business valuator for more help with this step.
What to Provide to the Business Valuator
Owners should generally be prepared to provide:
- Five years of financial statements prepared by an accountant, as well as statements from the current year.
- Premises information, such as the lease (if rented) or BC assessment (if owned).
- Material agreements, such as franchise agreements, equipment leases, financing agreements, and so on.
- List of furniture, fixtures, and equipment.
- Completed business analysis questionnaire and prompt attention to follow-up questions.
Your business valuator requires this information to provide an accurate picture of your business. As you begin the valuation process, make sure you’re committed to responding to the valuator on a timely basis.
Once they receive the information, they’ll provide you with a report indicating your business FMV, which will allow you to understand what your business is worth on the market.
Why is Business Valuation Important?
As a small business owner who’s been deeply involved from the start, you may not have a full understanding of your business’ current value. Getting an accurate valuation of your business will reveal, not only its true value but may even uncover ways to enhance its value to potential buyers.
Additionally, valuation helps you make more informed business decisions as you grow and approach retirement. Knowing the value of your company will help you make more confident decisions when it comes to succession planning.
Small Business BC is Here to Help
SBBC is a non-profit resource centre for BC-based small businesses. Whatever your idea of success is, we’re here to provide holistic support and resources at every step of the journey. Check out our range of business webinars, on-demand E-Learning Education, our Talk to an Expert Advisories, or browse our business articles.
