There are many reasons why a business owner or company need to know the value of a business – to sell or buy a business, settlement on litigation, capital restructuring, expansion of business etc.
How to price a company? Business valuation refers to the process of determining the current worth of a company and there are many techniques used to determine value. The typical standard of value utilized is fair market value. The fair market value is the price at which a business would change hands between an independent buyer and seller having the requisite knowledge and facts, not under any undue influence and having access to all of the information to make an informed decision. An analyst placing a value on a company looks at the company’s management, the composition of its capital structure, the prospect of future earnings and market value of assets etc.
It’s a common misperception to say that the company is worth these many times EBITDA (earnings before interest, taxes, depreciation and amortization) simply, as that doesn’t take into consideration the industry, business risks, cash flow expectation, debt and more. So, it is always advisable to do the business valuation by a valuation expert. Not knowing the actual fair market value of the business could cause the business owner to sell the business for a lesser price or buy a business at a high price than it actually worth. For these reasons, the cost to do the business valuation can be an excellent investment. Sometimes it may be a savings in millions by paying a right price or by taking a right decision not to invest in an unworthy business.
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The key drivers of business valuation are assets, liabilities, income, management, and location. To determine the value of your business, you need to follow any of the business valuation methods. These are also known as business valuation models that help you to understand the worth of your business. Business valuation models include the following approaches:
1. Asset-Based Approach
This approach of determining the business value totals up all the investment. Applying this technique to a corporation serves well as it will be included in company sale, whereas applying the same to a sole proprietorship becomes difficult as the assets belong to the same owner and separating them for business and personal use becomes a challenge.
2. Earning/Income-Based Approach
This method believes in the fact that a business’s real value lies in building wealth for the future. Keeping this in mind, a valuator determines the future cash flow by examining the records and also assesses the future financial risk.
3. Market Value Approach
This approach compares the value of one’s business to similar businesses that have recently sold. It can be applied only when there is a sufficient number of competitors in the market.