# Guide to Business Valuation: Understanding the Basics, Methods, Factors, and Examples

The business valuation is comparable to the value of the economic assets or present value of this company. It is estimated from the value of its equity added to its net financial debt.

In financial markets, this enterprise value is often considered more representative than market capitalization, which is limited to the number of outstanding securities multiplied by the share price.

The interest of the enterprise value is that it makes it possible to compare the performance of groups that do not have the same financial structure.

### How to calculate business valuation?

Setting an enterprise value means estimating a company at “fair value” (its market price).

This valuation is useful for internal purposes, when it comes to allocating goodwill (difference between the acquisition price of a company’s securities and its net accounting position);

It is also useful for external purposes, such as when a company must provide justification to the tax authorities or even carry out a minority sale between shareholders.

The value of the company, calculated at a time T, is conditioned by 3 elements:

• the economic situation (GDP growth, stock market climate, economic confidence index);
• regulatory changes (administrative and tax constraints, etc.).
##### Generally, the value of the company is assessed using the following formula:

Value of equity + value of net financial debt = value of the company.

Good to know: the enterprise value is a transparent indicator, because it includes the debt owed to creditors.

If the company is not in debt, but has excess cash, then its value is equal to the difference between the value of equity – cash.

For its part, the capitalization (value of the shares) is equal to the enterprise value from which the debts are subtracted. If the company has no net debt, but a surplus of cash, its capitalization is equivalent to the enterprise value + cash.

### 3 methods of assessing business valuation

Several methods are used to calculate the valuation of a company: the heritage approach, the comparative method and the yield method.

##### 1. Legacy method

It assesses the value of a company by adding up what it owns on the valuation day. Once this asset has been valued, the debts contracted are deducted. The result obtained constitutes the net assets, i.e. the enterprise value. The calculation formula is as follows:

+ capital gains/losses on intangible assets;
+ capital gains/losses on other economic assets;
+ capital gains/losses on financial fixed assets and holdings;
+ capital gains/losses on other balance sheet items = net assets.

Note: although this approach is rigorous from an accounting point of view, it has the disadvantage of not taking into account various factors, including the growth potential of a company.

##### 2. Comparative method

This method consists of identifying the prices charged and drawing inspiration from them to set a selling price.

The evaluation is carried out based on a scale or a ratio often observed in the same sector of activity. This valuation is cross-referenced with that of the company, itself derived from the last 3 balance sheets (+VAT). A general average is taken from this.

Mainly used when selling businesses, this method has the particular drawback of not taking the lease into account, as the value ranges obtained can also be very wide.

##### 3. Yield method

It is based on the real potential of the company and its ability to generate profits.

The valuation relates to the recurring result observed over several past financial years. This result is then valued by discounting at a rate X.

This evaluation method can be summarized as follows:

In a number of cases (start-up, strategic merger between two companies), the DCF (discounted cash flow) method is used. Enterprise value derives from the estimated cash flow that shareholders will receive in the future.

Reminder: cash flow corresponds to the cash flow available to a company.

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## Understanding Business Valuation: Methods, Factors, and Examples

Business valuation is the process of estimating the economic value of a company. It is a critical aspect of decision-making for entrepreneurs, investors, and other stakeholders. Valuation can be a complex process that involves a variety of factors, such as financial metrics, market trends, and industry performance. This guide provides an overview of the basics of business valuation, including the key factors that impact a company’s value.

All of your company’s strengths and weaknesses serve as the basis for its assessment, which itself serves as the basis for negotiation with the potential buyer. But keep in mind that “assessing” consists in appreciating what makes the value of your company and not in fixing its sale price! To estimate the value of your business, there are different approaches: asset valuation, future profitability, market price. And of course, you can combine several of them.

## Understanding the Purpose of Valuation

The primary purpose of business valuation is to determine the worth of a company in the market. This can help stakeholders make informed decisions, such as whether to buy or sell a business, or how to invest their capital.

It is an essential aspect of any merger and acquisition (M&A) process, and it is also useful for investors who want to evaluate the potential return on investment.

There are several key factors that impact a company’s value, including:

#### Financial metrics such as revenue, earnings, and cash flow

Traditional financial statements (balance sheet and income statement), even if they present the financial information as faithfully as possible, contain certain limitations.

Analysis of the statement of cash flows (formerly the statement of changes in financial position) makes it possible to complete the diagnosis of performance and circumvent most of the difficulties associated with an analysis that is limited to review of the income statement and balance sheet. It represents an essential complement to any diagnosis of a company’s financial situation and clarifies the judgment made on profitability, efficiency and solvency. In addition, it provides elements of growth management analysis.

#### Market trends and industry performance

Market trends refer to the direction and pattern of change in the behavior of the market over time. These changes can be driven by a variety of factors, including consumer preferences, technological advancements, economic conditions, and regulatory changes. Understanding market trends is important for businesses to make informed decisions about their products, services, and marketing strategies.

Industry performance, on the other hand, refers to the overall financial health and growth of a particular industry or sector. This can be measured by various performance indicators such as revenue, profitability, market share, and growth rate. Understanding industry performance is important for investors, stakeholders, and businesses to identify opportunities for growth and to make informed investment decisions.

#### Company assets and liabilities

Company assets refer to the resources that a company owns or controls and that have economic value. Assets can be tangible, such as buildings, land, inventory, and equipment, or intangible, such as patents, copyrights, and trademarks. Assets can also include financial instruments like stocks, bonds, and cash.

Liabilities, on the other hand, refer to a company’s debts or obligations that it owes to others. Liabilities can be current or long-term, and they can include things like loans, accounts payable, and accrued expenses. Some liabilities may also be contingent, meaning they are dependent on the outcome of future events, such as lawsuits or warranties.

The difference between a company’s assets and liabilities is known as equity or net assets. Equity represents the residual interest in the assets of a company after deducting all liabilities. In other words, it is the amount that would be left over if all the company’s assets were sold and all its liabilities were paid off.

#### Management team and corporate strategy

The management team refers to the group of individuals who are responsible for overseeing and directing the operations of a company. This team is typically composed of executives and other key personnel who are tasked with making strategic decisions, setting goals, and managing the company’s resources to achieve those goals.

Corporate strategy, on the other hand, refers to the overall plan or direction of a company. It is a high-level, long-term plan that outlines how the company intends to achieve its goals and objectives. Corporate strategy encompasses a range of activities, such as identifying target markets, developing new products or services, and expanding into new regions or markets.

The management team plays a critical role in developing and implementing a company’s corporate strategy. They are responsible for analyzing market trends and competitive forces, identifying growth opportunities, and making strategic decisions about resource allocation and investment. Effective management teams are able to align the company’s operations and resources with its corporate strategy to achieve long-term success.

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## Business Valuation Methods with Examples

There are several valuation methods used in the industry, including:

### Asset-based valuation

Valuation of assets consists of finding the best possible price for the debtor’s assets, which presupposes knowledge of these assets, their valuation and sometimes their development for optimization purposes.

The asset-based valuation method calculates the value of a business by adding up all of its assets and subtracting its liabilities. This method is most appropriate for companies with a lot of tangible assets, such as real estate, manufacturing, and retail businesses.

For example, if a manufacturing company has a factory and equipment worth \$1 million and liabilities worth \$500,000, its asset-based valuation would be \$500,000.

### Market-Based Valuation

The market-based valuation method compares the business to similar businesses in the same industry to determine its value. This method looks at metrics such as price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and price-to-book (P/B) ratio.

For example, if a technology company has a P/E ratio of 20 and an earnings per share (EPS) of \$5, its market-based valuation would be \$100 per share.

### Income-Based Valuation

The income-based valuation method calculates the value of a business by analyzing its income and cash flow. This method is most appropriate for service-based businesses, such as consulting firms and software companies. It uses metrics such as discounted cash flow (DCF) and capitalization of earnings to determine the business’s value.

For example, if a consulting firm has an annual cash flow of \$500,000 and a discount rate of 10%, its income-based valuation would be \$5 million.

This approach involves projecting the company’s future cash flows and then discounting them to their present value using a discount rate. For instance, if a company is expected to generate \$5 million in cash flows over the next five years, and the discount rate is 8%, the present value of those cash flows would be around \$18 million.

### The comparative method linked to the Owner Benefit

This is clearly the method that is most used in medium-sized transactions in the USA.

It is about valuing a company in relation to its ability to generate profitability for its owner. A business that earns nothing, is worth nothing, except that its assets have an intrinsic value (see above).

A case is very often estimated as a multiple of the “Owner Benefit”.

Concretely, the Owner benefit is the cash that the owner withdraws from his business whether in the form of salary, dividends or personal expenses borne by the company. We can summarize his calculation as follows:

Owner Benefit = Net Profit + Add Backs

The sum of Add Backs corresponds to reinstatement of charges that have been deducted from the company’s results, but which correspond to benefits for the owner or tax charges that have not been disbursed:

– the owner’s salary,
– health insurance for the owner,
– the owner’s personal car expenses,
– The shock absorbers…..

##### Calculation

This calculation deserves to be looked at closely in order to validate each point. Typically, the seller provides an accurate chart that shows this detail. The Owner Benefit is also sometimes called Seller Discretionary Earning, Adjusted Net, Net Earning, or even sometimes Cash Flow (on the Bizbuysell site for example).

The multiple, on the other hand, is defined by type of business and there are references to this subject online. From experience, this multiple has often been between 2 and 3, but in some sectors it can go up to 7.

In other words, the cases I have worked on have very often sold at a price corresponding to 2 to 3 years of profitability.

The average sale price of companies below \$500,000 in value is 2.3 times the owner benefit.

It is important to have three years of accounting to analyze this point. A sudden increase in profitability in the year preceding the sale may mean that the owner has artificially inflated profitability by omitting charges, for example, in order to increase the resale value.

### The comparative method

As its name suggests, it is a question here of comparing the company to companies in the same activity, of the same size and to know on what multiples these companies have sold. Here, the difficulty is to find the information. For classic activities, it is quite easy to find on the internet. For more confidential activities, the search will be more difficult. A site like BV Market Data has a lot of information (nothing free though).

### Conclusion

The final value is obtained by weighting these three criteria. If the sale price is very far from the value at which you estimate the deal, it will be difficult to reach a conclusion and it sometimes takes months for the seller to realize, in the end, that he is not has no chance of selling his business, because he has set a selling price that is far too far from reality.

For example, we have negotiated deals in the following criteria:

– value estimated by the buyer \$200,000.00,
– selling price by the seller \$250,000.00,
– 1st offer by the buyer: \$180,000.00,
– deal concluded at \$220,000.00.

In this case, the seller and buyer positions were not too far apart. Thus, the negotiation took place quickly and calmly leading to a successful transaction.

In another case, the buyer estimated (correctly) that a deal was worth \$150,000.00. The seller wanted \$250,000.00. The buyer’s 1st bid was \$130,000.00. The seller refused the offer directly, cutting short the negotiation by having this word “Insulting” (insulting). More than a year later, this business finally sold to another buyer at \$140,000.00.

Finally, it should be noted that buyers “E2 visa applicants”, regularly pay a slight surcharge, because the seller knows full well that, for the buyer, it is the key to the United States. In addition, the seller will have to be patient (2 to 3 months) and also take the risk of seeing everything canceled if the visa is refused, so he will be more demanding on the price than in a classic sale.

It is in these cases that having a broker accustomed to the workings of immigration and surrounded by lawyers specialized in this field and qualified CPA (accountant) will make the difference!

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