How to Value a Business
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A business is generally valued by looking at what it earns, what it owns and what similar businesses are worth. However, there isn’t one formula that can give you an exact business valuation.
The right approach depends on the type of business, its finances and why the valuation is being carried out.
This guide will explain what a business valuation is, how business valuations work, how to estimate the value of your business, the main approaches used and what can increase or reduce the value of a business.
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What is a business valuation?
A business valuation is an estimate of the financial value of a company at a particular point in time.
There are several ways of reaching that estimate, but most approaches consider one or more of the following:
• Earnings: What profit or cash flow does the business generate, and how sustainable is it?
• Assets: What does the business own once its liabilities are considered?
• Market comparisons: What have similar businesses sold for or how are comparable companies valued?The most appropriate approach depends on the type of business and why the valuation is being carried out. In some cases, more than one method may be considered to build a more rounded picture of value.
You might need a business valuation when:
• Selling or buying a business
• Bringing in an investor
• Planning for retirement or succession
• Changing shareholders or ownership
• Reviewing the longer-term financial position of the companyIt’s also important to distinguish between a valuation and a sale price. A valuation provides an informed estimate of what the business is worth. The amount eventually agreed with a buyer can also be influenced by negotiations, demand, deal structure and market conditions.
How much is my business worth?
Your business valuation will depend on the method used and the financial performance, assets and risks of the company rather than its turnover alone.
A business generating £2 million of revenue but very little sustainable profit, for example, could potentially be worth less than a smaller business with strong margins and predictable recurring income.
For many established small businesses, a useful starting point is to look at earnings and apply an appropriate valuation multiple.
For example:
Maintainable earnings × appropriate multiple = indicative business value
The challenge is establishing both figures. You need to understand what level of earnings is genuinely sustainable and what multiple, if any, is appropriate for that particular business.
That is why a business valuation is best treated as an informed estimate rather than a guaranteed sale price.
What information do you need to value a business?
A useful valuation starts with an accurate and current picture of the business’s finances.
Before trying to estimate your business value, it helps to have access to:
• Recent annual accounts
• Up-to-date management accounts
• Profit and loss information
• Cash flow information
• Details of business assets and liabilities
• Outstanding debts
• Details of recurring income and contracts
• Information about unusual, one-off or owner-specific costsThese figures help you understand what the business is genuinely earning. That distinction can be particularly important when establishing sustainable or maintainable profit.
For example, the most recent year’s accounts may include an unusually large one-off expense that isn’t expected to happen again. Equally, they could contain an exceptional piece of income that makes profits look stronger than they normally would.
Owner-specific costs may also need to be understood when looking at the underlying performance of a company.
Accurate bookkeeping and up-to-date accounts make it easier to identify these items and establish a financial picture that reflects the business as it operates today.
How to value a business quickly
You can make an initial estimate of a business’s value without carrying out a full formal valuation. The aim at this stage isn’t to arrive at a definitive figure. It’s to establish a sensible starting point based on the information available.
A practical process is:
1. Review recent financial performance. Look at several years of accounts where possible rather than relying on a single period.
2. Establish sustainable earnings. Work out what level of profit the business can reasonably be expected to maintain.
3. Review assets, liabilities and debt. Understand what the business owns and what it owes.
4. Choose an appropriate valuation method. This could involve applying an appropriate earnings multiple, assessing net assets or using comparable business transactions.
5. Consider strengths, risks and future prospects. Think about customer concentration, recurring income, growth opportunities and owner dependence.
6. Sense-check the result. Compare the figure with the wider financial position of the company and, where suitable data is available, similar businesses or transactions.
A simple business valuation example
Imagine a business has reported annual profits of:
• Year one: £85,000
• Year two: £105,000
• Year three: £110,000After reviewing the accounts and adjusting for any unusual or one-off items, you decide that £100,000 represents a reasonable estimate of maintainable annual earnings.
For illustration, suppose you then applied a multiple of four:
£100,000 maintainable earnings × 4 = £400,000 indicative value
This does not mean that four is the correct multiple for this business or that the business is guaranteed to sell for £400,000.
The appropriate multiple would depend on factors including the sector, risk, growth prospects, recurring income, customer concentration and current market conditions. A buyer may also make further adjustments after carrying out due diligence.
This type of calculation is useful for producing an initial indication. It isn’t a substitute for a formal specialist valuation where one is required.
What are the main business valuation methods?
There are several ways to value a business, and the most appropriate approach will depend on the type of company and the reason for the valuation. In some situations, more than one method may be used to help sense-check the resulting figure.
Earnings or profit multiple
An earnings-based valuation takes a measure of sustainable profit or earnings and applies an appropriate multiple.
For example: Maintainable earnings × appropriate multiple = indicative business value
The challenge is establishing both sides of that calculation.
First, you need to understand what level of earnings is genuinely maintainable. You then need a suitable multiple that reflects the nature, size, risks and prospects of the business.
This approach is well suited to established, profitable businesses where ongoing earnings are a major part of what a buyer is paying for.
Asset-based valuation
An asset-based valuation looks at the value of what the business owns, less what it owes.
This might include assets such as:
• Property
• Machinery and equipment
• Vehicles
• Stock
• Cash
• InvestmentsLiabilities and debts are then taken into account.
Asset-based valuations are most relevant to businesses with substantial tangible assets, such as property, machinery, vehicles or stock. They may be less useful on their own for service businesses whose value lies mainly in their people, customer relationships or future earnings.
Discounted cash flow
A discounted cash flow valuation estimates the cash the business is expected to generate in the future and then works out what those future cash flows are worth in today’s terms.
In simple terms, money expected several years from now is usually worth less than the same amount received today.
This method can be useful for businesses with relatively predictable future cash flows, particularly where longer-term forecasts can be made with reasonable confidence. It is less straightforward where future income is volatile or difficult to predict.
Comparable business valuation
A comparable valuation looks at the value of similar businesses or relevant transactions. This could involve examining sale prices or valuation multiples for companies with similar characteristics.
This approach can be useful where there is reliable information about similar businesses or recent transactions in the same market. The more different those businesses are in size, profitability, customers or risk, the less useful the comparison becomes.
How do you value a small business to sell?
If you’re valuing a small business ahead of a possible sale, it helps to think about the company from a potential buyer’s perspective.
A buyer isn’t simply purchasing the previous year’s turnover. They’re considering what the business is likely to generate after they take ownership and the level of risk involved.
They may look particularly closely at:
• Sustainable profitability
• Recurring or reliable income
• Customer concentration
• Future growth potential
• Unusual or owner-specific costs
• How dependent the business is on its current ownerOwner dependence can be especially important. If key customer relationships, decisions and specialist knowledge sit with one person, a buyer may see greater risk in taking over.
Documented processes, a capable team and relationships spread across the organisation can make the business easier to transfer.
How do you value a professional services business in the UK?
Professional services businesses can require a slightly different approach because much of their value may sit in future earnings rather than physical assets.
For an accountancy practice, consultancy or similar firm, a valuation may therefore look particularly closely at:
• Recurring or retained clients: How predictable is future revenue?
• Profitability: Are earnings consistent and sustainable?
• Client concentration: How much revenue depends on one or two clients?
• Strength of the team: Can the business operate without one key individual
• Reputation: Is the firm able to retain clients and win new work?
• Contracts: Are there longer-term or retained agreements in place?
• Owner dependence: Are client relationships likely to transfer to a new owner?For a professional services business, it is therefore important to understand not only how much the company earns, but how predictable those earnings are and whether they are likely to transfer to a new owner.
What can increase or reduce the value of a business?
Many of the factors used to value a company ultimately affect one of two things: its potential to generate future returns and the level of risk attached to those returns.
What can increase business value?
Factors that may support a stronger valuation include:
• Consistent or growing profits
• Strong cash flow
• Recurring or reliable revenue
• A diverse customer base
• A strong management team
• Clear financial records
• Realistic growth opportunities
• Lower dependence on the ownerWhat can reduce business value?
Factors that may reduce business value include:
• Falling or inconsistent profits
• Reliance on one or two major customers
• Uncertain future income
• Poor financial records
• Significant debts or liabilities
• Limited growth prospects
• Heavy reliance on the ownerMarket conditions can also affect value. Demand for businesses in a particular sector, access to finance and wider economic conditions can all influence what buyers are prepared to pay.
How can your accountant help when valuing a business?
Your accountant can help make sure the financial information being used is accurate, current and gives a realistic picture of how the business is performing.
This can include:
• Reviewing accounts, cash flow, assets, liabilities and debt
• Identifying unusual or one-off income and costs
• Helping to establish a sustainable level of profit
• Preparing financial information ahead of a sale, investment or other major decision
• Working alongside valuation, corporate finance or legal advisers where additional expertise is neededHaving this information in order can make it easier to estimate the value of the business and prepare for a more formal valuation where required.
Understand the numbers behind your business value
A reliable business valuation starts with a clear understanding of your finances, but arriving at the right figure can require more than simply applying a multiple to your latest profit.
At Mollan & Co, our business valuation services help owners assess the value of their businesses using the valuation methods most appropriate to their circumstances.
Whether you’re considering selling your business, buying out a partner, planning for succession or simply looking for a clearer idea of what your business is worth, we can help you understand the numbers behind the valuation.
Our team has decades of experience working with SMEs and can guide you through the process, from reviewing your financial information to assessing the factors that may influence the final figure.
Contact Mollan & Co to find out more about our business valuation service and book a free, no-obligation consultation.
Author ProfileI'm the owner and Managing Director of Mollan & Co Accountants. I'm a skilled and efficient accountant with more than 20 years of experience in the industry.
I developed valuable skills in business and commercialisation through my work in the science and technology departments within the Scottish University sector. Then, in 2001, I formed my own internet-based marketing company, producing and distributing 360° virtual reality tours for the Scottish tourism sector.
I now use my commercial skills, expert tax knowledge and first-hand experience to help other businesses grow and flourish through strong accounting practice.
Our success at Mollan & Co is directly related to the success of our clients.
