Potential buyers of your business will need to understand what sort of opportunity they are receiving by investing in it. Most businesses have a combination of assets, the primary capital consideration, as well as cashflow, the income element. Some businesses are more heavily weighted in one direction than the other, although the majority will have both elements
Buyers will often assess your business by working out how heavily weighted your company is in terms of its income compared with its assets. This is crucial to understand in terms of placing a business on the market. Some brokers have more experience selling income-based businesses, but others are more focused on capital-based businesses. Finding a broker who suits your situation is essential and will depend on your accounts and the type of business you run.
Income Considerations: The Goodwill part of the business
Businesses built around their income potential tend to have higher turnover to expenditure ratios which mean that money can be taken out of the business by the owners as income, or for other purposes, during or at the end of each tax year.
A typical income-based business will not have to reinvest heavily in stock or other assets to continue trading. Think of a business that is based on providing a service, such as an office cleaning company, for example. In such a business set-up, there are few capital costs, outside of cleaning equipment and vans, and much of these can either be finances with costs spread over time.
Few businesses are fortunate enough not to be reliant on their stock or other assets, but where the value of a business is judged by its income only, then a multiple of earnings before interest and tax and operational profit is considered the normal means of estimating the value of a company. In the example of an office cleaning company, this figure would make up nearly the whole value of the business, because expenditure associated with such a business is built into the cost of each job, like time and travel costs, so the gross profit of each job adds in a directly proportional way to the income generated, without the need to factor in many assets.
Whether you need to add the value of assets to this income valuation or not – and most business proprietors do – it is important to note that income can go up, if the business is grown successfully, or go down if competitors drive down the sale price of the service. When calculating the proportion of the value of a firm due to its income, the discounted cash flow – or DCF – method is also often used. This method anticipates the future cash flow of the business.
It is important to remember that any valuation must take into account the fact that income is variable. When calculating the element of a business’ income that relates to goodwill you will need the profit and loss accounts over the last three trading years, although some adjustments might be necessary to the profits column in order to get a true picture of the profits for the goodwill calculation. This is sometimes referred to as the average maintainable earnings.
The main benefit of a successful business with a substantially consistent operating profit is that the goodwill consideration is multiplied as there is growth and ongoing profitability.
Capital Considerations: How to value assets and property
By contrast, the valuation of capital in a business is more fixed. Normally the capital in the business are the assets of the business in question, these can range from property to desks, computers to machinery. Anything that has a saleable value is considered within the capital consideration.
Many businesses with no property and few assets other than furniture and technology, knowledge-based businesses such as recruitment companies, have very low capital consideration other than the cash held in the bank (discounting outstanding loans and debt).
Property, within reason, normally retains the market rate, but it is useful to have a valuation of the property should the business be prepared for sale as it is important that the property is valued at current market rate, not the previous purchase price or even what is declared within the accounts.
Other assets need to be considered sensibly, stock generally is worth less than what it was purchased for and certainly not at the saleable value. If stock has been held for longer than twelve months it may not have any value. Computer equipment and office furniture will depreciate over the course of a number of years.
The Formula for Business Valuation for sale: how to treat Goodwill and Assets
For most businesses that are sold, however, the income calculation is added to the assets’ worth to provide a total valuation. Along with the intellectual property and other intangible assets of a company, its capital worth comes down to all of the so-called fixed assets it has, such as property, stock, furniture and office equipment. In addition, liquid assets, like money held in the bank, should be included as part of the valuation.
So, normally you end up with a formula like this:
V = m*aE + C
V = Valuation
m = Multiplier
aE = Adjusted EBIT (or adjusted operating profit)
C = Capital (a combination of all assets valued at market rate)
Often we will quote ranges of valuation as selling a business with lots of complex assets or trading figures means that there is not necessarily a single figure which is the right price for a company. The variance can be much greater than that.
To fully value a business, whether for sale or for other purposes, requires the services of a specialist, experienced in the business buying and selling marketplace.
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