Small business guide: How to calculate business value

Do you know how much your business is worth? If not, do you even know how to calculate business value in the first place? For a small business owner, there can be a number of reasons why it’s important to be able to calculate the value of a business.

In this guide we’re going to explain why and how you should be calculating the value of a business, including:

• How much is my business worth?
• How to calculate the value of a business

So if you’re ready to value a business, here’s everything you need to know to get started.

How much is my business worth?

For small businesses, knowing the value of their business is important for a number of reasons, not just when they are considering selling it:

Attracting investors

If a small business is looking for investors, potential investors will want to know the value of the business before investing. By knowing the value of their business, small businesses can confidently approach investors and make a strong case for investment instead of wondering ‘how much is a business worth?’.

Making informed decisions

Knowing the value of the business can help small business owners make informed decisions about growth strategies, expansion plans, and financing options. Without this information, it can be difficult to know which direction to take the business in.

Negotiating with partners

Small business owners may need to negotiate with partners, suppliers, or customers. Knowing the value of the business can help them negotiate from a position of strength, ensuring that they get a fair deal.

Planning for retirement or exit

Small business owners may plan to retire or exit the business at some point and need to ask ‘how much is my company worth?’. Knowing the value of the business can help them plan for this transition, ensuring that they get a fair price for their business.

Benchmarking performance

Knowing the value of the business can help small business owners benchmark their performance against similar businesses in their industry. This can provide valuable insights into areas where the business is performing well and areas where it may need improvement.

Factors that can contribute to business value

There are several factors that can make a business valuable, and they can vary depending on the industry and the specific business. However, some of the most common factors that contribute to a business's value include:

• Revenue: The amount of revenue a business generates is often a primary factor in determining its value. Generally, a business with higher revenue is considered more valuable.
• Profitability: Profitability refers to the amount of profit a business generates after expenses are deducted. A business that is consistently profitable is more valuable than one that is not.
• Growth potential: A business that has potential for growth in the future is often considered more valuable, as investors are looking for businesses that can generate more revenue and profits over time.
• Customer base: A strong customer base can add value to a business, as it indicates that there is demand for its products or services.
• Intellectual property: Patents, trademarks, copyrights, and other forms of intellectual property can increase a business's value, as they provide legal protection for its products or services.
• Brand recognition: A well-known brand name can add value to a business, as it indicates that the business has established a positive reputation in the market.
• Management team: The quality of a business's management team can also contribute to its value, as a skilled and experienced team is more likely to drive growth and profitability.
• Assets: Tangible assets such as equipment, inventory, and real estate can also increase a business's value, especially if they are in good condition and have a high resale value.
• Market position: A business that has a strong position in its market, such as a dominant market share or a unique competitive advantage, is often considered more valuable.

How to calculate the value of a business

So, how do you calculate the value of a business? Valuing a small business can be a complicated process, but it's essential to get it right to ensure that you get a fair price for your hard work. In this blog post, we'll take a look at how to calculate the value of a small business.

Tally the value of assets

The first step in how to calculate the value of a business is to work out the value of everything the business owns, including all equipment and inventory. You'll then need to subtract any debts or liabilities to get the net asset value. The value of the business's balance sheet is at least a starting point for determining the business's worth, but it's probably worth a lot more than its net assets.

Base it on revenue

Another way to value a small business is to base it on revenue. How much does the business generate in annual sales? Calculate that and determine, through a stockbroker or a business broker, how much a typical business in your industry might be worth for a certain level of sales. For example, it might typically be about two times sales.

Use earnings multiples

A more relevant measure is probably a multiple of the company's earnings, or the price-to-earnings (P/E) ratio. Estimate the earnings of the company for the next few years. If a typical P/E ratio is 15 and the projected earnings are £200,000 a year, the business would be worth £3 million.

Do a discounted cash-flow analysis

The discounted cash-flow analysis is a complex formula that looks at the business's annual cash flow and projects it into the future and then discounts the value of the future cash flow to today, using a "net present value" calculation. It is easy to find and use an online NPV calculator.

Go beyond financial formulas

Don't just base your assessment of the business's value on number crunching. Consider the value of your business based on its geographical location. In addition, consider its potential strategic value to a would-be acquirer if there are business synergies. For example, if your business is located in a desirable area with high foot traffic, it may be worth more than its net assets.

In conclusion, valuing a small business is a complex process that requires careful consideration of many different factors. By using a combination of financial formulas and a deeper analysis of your business's unique characteristics, you can arrive at a fair valuation that accurately reflects the business value. Remember to seek independent financial advice if there’s anything you’re unsure about and work with a reputable business broker or other professional to ensure that you get an accurate and fair valuation.