If you’re planning to sell or buy a business, knowing how to value the business is critical. And although business value comes to mind more often in relation to selling or buying, there are other reasons why you might want to consider a business valuation.
Valuing your business can be beneficial to obtain business financing, attract investors, or for the purpose of exiting the business – something we mentioned in our article on succession planning.
Of course, the business valuation task might not be something you would undertake yourself, which is precisely why there are business valuers that have extensive experience in different areas of finance, investments and commerce. These professionals are usually well-versed in corporate finance or corporate management, financial markets, and investment banking.
But how do you value a business? More importantly, is there a specific formula on how to value a business in Australia?
What you need to consider when valuing your business
Part of knowing how to value a business for sale in Australia is considering certain factors that contribute significantly to its market price. These include business assets, your years of operation, and your business’s financial position.
Business assets
Both the tangible assets and intangible assets of your business affect its value. Tangible assets include property, equipment, tools or machinery and inventory. Intangible assets include customer loyalty and goodwill, being a well-respected brand, intellectual property (e.g., patents and trademarks), a huge client database and strong growth potential.
Years of operation
In general, businesses that have been operating for a long time already have a clear track record of performance in terms of customer acquisition, sales, and overall financial growth. They would also have a substantial loyal customer base as a source of repeat business and key business relationships for referrals. Conversely, newer businesses that are doing well at the moment may be challenged to demonstrate longevity in financial performance.
Financial position
Businesses with a strong financial position or who are financially healthy have excellent chances of pushing for more favourable sales terms.
Make sure your financial statements for a certain number of years are ready, including cash flow forecasts, debt records, annual turnover, and P&L statements.
Aside from the aforementioned factors, one other item that can affect your business value (especially when business valuation is done only because of an impending sale) is your reason for selling.
If you’re being forced to sell quickly because of urgent financial needs, the value of your business can be driven down. But if you can engage in balance negotiations with a willing buyer and as a willing seller, then you’ll have a better chance of securing a better financial outcome.
Different valuation methods
While there is no one specific valuation method that’s considered superior to the rest, a business valuer might advise you to use a combination of methods to get a more accurate final business value.
Below are some common business valuation methods you might want to familiarise yourself with to have a better grasp of the process.
1. Return on investment (ROI)
To calculate the value of your business using the return on investment (ROI) method, you need to consider the net profit of your business using the following formula:
ROI = (net annual profit/selling price) x 100
In case you have a specific ROI in mind, you can also use it in calculating the price.
Selling price = (net annual profit/ROI) x 100
2. Current market value
You can also check your business’s market value by taking into consideration the industry you are in. If future growth projections for your industry are good, then that could work to your advantage.
Make sure you dig deeper and research industry business sales in your relevant market. Also, check for statistical data grouped by industry with the Australian Bureau of Statistics (ABS). This way, you’ll have an independent assessment of how the economic conditions of the industry your business is operating in.
3. Cost of starting a business from scratch or entry cost valuation
By benchmarking your business with the current market conditions, you’ll have a fair idea of the value of your business. This means calculating how much you’ll need to invest to start the same business from the ground up. Your calculations need to include licensing fees, the cost of getting various types of permits, equipment, tools and devices, commercial property leasing or buying, acquiring inventory, marketing and promotion, product development, staff recruitment and training, payroll, etc.
4. Asset valuation
Using the asset valuation method entails accounting for all the tangible and intangible assets and liabilities (as described in a previous section) of your business. This way, you can determine the asset value, which is the difference between your assets minus your liabilities. The asset valuation method gives you a more or less accurate picture of how your business would be worth if it were to be sold today excluding any allowance for goodwill.
5. Comparable sales method
Applying the comparable sales method requires you to find out the sales of similar businesses that belong to the same industry and your relevant market. Knowing how much similar companies have sold for will give you a fair idea of how much your business is worth.
You can obtain helpful information from business sales listings, industry journals or magazines, newspapers, websites, and business brokers who have facilitated such sales transactions.
The value of expert advice
As much as possible, consider getting the help of a professional when valuing your business. Experts who can assist you through this process include your accountant, financial advisor, business consultant, business broker and business valuer.
Aside from providing expert advice in business valuation, they can help you analyse your finances and put things in order before you entertain prospective buyers.
Preparation is key
When planning to sell your business in Australia, preparation is key, and we’re not just talking about the business valuation aspect here. To streamline the negotiation process, you need to be ready with the following information and documents:
- Legal information: This includes contracts, leases, insurance policies, registration documents, compliance certificates, permits, licences, etc.
- Business/market profile: Here, you should include details of market conditions (including competitor profiles), competing business comparisons, sales data, business history, business plans, business protocols, operations information, etc.
- Human resources, vendor/supplier, and customer data: Keep documents involving your staff, vendors, suppliers and customer information on hand.
Correctly valuing your business is essential for succession planning
By knowing the value of your business now, whether you intend to sell in a year’s time or after five years, you don’t run the risk of underestimating the value of your business and losing money during a sale. You’ll also be able to come to the closing table prepared, with all the documents and numbers on hand.
Value your business now
Business valuation may not be your top priority right now. However, this task is not something that you can put off until you decide to sell your business.
Having a clear idea of the value of your business will help you deal with other critical business matters, including succession planning, getting more investors, or financing.
So, make sure you include business valuation in your project list this year.
If this blog has sparked any questions and you’re not sure where to start when valuing a business, speak to your Ledge Finance Executive today. We have a referral network with a number of businesses in professional services who we can put you in touch with to find out how much your business is worth and guide you through the path you choose for your business. Call our offices on (08) 6318 2777 or email secure@ledge.com.au and we will be in touch.
