There are 3 approaches to valuing a business – market, income and asset. A thorough business valuation requires that you consider methods from all approaches. Each valuation method looks at a company from a different perspective, and sometimes the results vary widely. How do you choose the best method?

Selecting Methods

The asset-based method described in Part 8 produces the minimum value of a company because it assigns no value to goodwill. So your first step is to ignore any method that produces a value less than the adjusted asset method. If your company has little or no earning capacity then the adjusted asset method may produce the highest result and it is the best method.

The percentage of annual sales method from Part 6 often produces the highest value of a company because it is based on top-line sales only and it ignores gross profits and operating expenses. Because it produces a high value many owners latch on to this method even though it often produces unrealistic results.

Since the primary driver of business value is earning capacity, the multiple of seller's discretionary earnings (SDE) and capitalized cash flow methods tend to produce the most realistic values. On the flip-side, potential buyers and their lenders will also be looking at earnings to justify the selling price.

Range of Values

Typically the adjusted asset method will be the lowest, the percentage of annual sales method will be the highest, and the SDE and cash flow methods will fall somewhere in-between. This is the range of values for your company. Because valuation is based on a hypothetical sale of your company, the value of your company depends upon the most likely terms of the sale. If you had to sell fast for all cash then you would probably sell near the low end. If you had time and were willing finance a significant portion of the selling price then you are likely to sell closer to the top. Under normal circumstances the value of your company will fall near the middle.

Limitations

The methods described in this series are stripped down versions of some common valuation methods.

No matter how much time and effort you put in to valuing your company, you will never be able to match the training and experience of a valuation professional.

In addition to expertise, a valuation professional brings another critical factor to the process - objectivity. There are many judgment calls made during the valuation process. No matter how objective you may have been in doing your valuation, your objectivity will still be subject to reasonable doubt.

Your lack of valuation experience and questionable objectivity means that your self-prepared valuation will hold little weight with outside third parties. Doing your own valuation only makes sense if you are going to use the results for your own personal or business purposes. Basing a major decision or course of action on the results of a self-prepared valuation is not a good idea. The impact of using an off-the-mark value may cost you many times the cost of hiring a valuation professional.

On the other hand, your self-prepared valuation will be better than many of the free or low-cost valuation services available online. Online services often use proprietary data and methods that are not well defined with little analysis of your company.

Conclusion

Doing your own business valuation using the instructions from this series will produce a result that will give you a good idea of what your company is worth. During the valuation process you will learn more about your company, and what drives its value. At that point you will know more about your business than most owners, and will be able to manage it more effectively.