The Big Question
After your business has been in the game for a while, there comes a time when you arrive at the question: what is the worth of my business? How long it has come and where my business currently stands.
It is important to note that valuation of business is not just a matter of few good words, basic arithmetic functions, and shiny balance sheets. It takes a whole process to break the business down and weigh it systematically, to arrive at a concrete figure that denotes the value and worth of your business.
The Meaning of Worthiness Varies from Business To Business
The meaning of “worth” varies from person to person and business to business. For some people, the worth is measured by seeing how much that business is contributing in the society. Is it making a positive difference? Does it make other people’s life better? The simple affirmation is enough for them.
Then, there are people who measure the worth of their business in numbers and figures, which can be translated into something meaningful. Such people evaluate their business based on their earnings, historic income records, etc.
On top of that, it’s the economic conditions that determine the worth of your business. It is imperative to assess the economic conditions in which your business is operating. Because as we all know, economical conditions affect everyone associated to a particular business – buyers, sellers, investors.
The question remains, what does the value or worth of a business actually stand for? The value of your business is the value for which it can be sold. It is the price at which you will sell the business, if ever the time comes. This value or price keeps on decreasing or increasing with the change in market circumstances.
As we said it earlier, valuation of business is a systematic procedure. There are three methods to evaluate your business.
- Market approach
- Asset approach
- Income Approach
Market is solely operated on two main functions: supply and demand. Anything that is a part of market has a demand attached to it and that demand is where every business opportunity stems from. The market approach of evaluating your business is a way where you can calculate the worth of you business by assessing how much profit is your business capable of making. The more the profit, the higher will be its demand.
It can be explained by a simple fact that a machine that is small, will value more if it makes more units of the product as compared to a large machine that produces lesser units. So, the demand of your business depends on it profitability. And at any given time, the value of your business will be calculated after evaluating the market conditions. If your business is similar to many others out there, then the value of your business will be decided after looking at current market rates. Your business will be evaluated against all those other businesses like yours to see if you are offering something more valuable than the rest.
In market approach, the equilibrium is often maintained. The market forces make sure that both parties agree at a price at which the buyer is willing to buy and the seller is willing to sell. This is the price of your business and is often called the fair market price.
This method is simple. It considers all the assets and liabilities involved in the business. This method is used by those businesses that have a heavy concentration of assets, even when there is not enough return on the assets. When using this approach, the basic question that becomes the sole premise is how much it will cost me to create a similar business, if I had to, in order to get the same economical benefits out of it.
In this approach, we add up all the assets that the business owns and operates, and calculate all the liabilities it owes in entirety. The difference between these two is the net worth of your business.
It sounds very easy and simple, but as they say, the devil is in the details. It is not as easy to decide which asset and liability should be made part of the valuation, or once the value has been calculated, then what standards it should be measured on or what is the actual worth of the assets. When it comes to these details, it all becomes quite difficult to calculate. Other than this , one issue that analysts often face while using this approach is that it is not easy to determine the assets and liabilities which are not on the balance sheet and this may lead to over or under valuation of your business.
This method is about what the name stands for – Income!
Remember the machine that was small but made more units than the large machine that made less? In this method, we calculate how much money in total does that machine makes for you. In this method, every form of income is calculated and accumulated to see what the business makes in total. In includes profit, employees’ salaries, perks and allowances, insurance premiums, cars given by the company, interest expenses, etc. Everything is calculated and adjusted against the net income to see what the business makes at the end of the day. And this is not only for one time. When buying a business or merely evaluating its worth, you take out all the historical records to see the revenue patterns and income trend of the business. It is the net income of the business that will drive the buyers’ interest.