Determining The True Value of Your Business

December 27, 2011  |   San Diego Bookkeeping   |     |   Comments Off on Determining The True Value of Your Business

As someone who has sold a lot of businesses and bought a few myself I look at business valuation very seriously from both sides of the equation. To me, the only “real” value of a business is determined by what the market will bear in getting an actual deal done.The rest is just BS and making people feel good but it doesn’t jibe with reality and I don’t think it helps in the long run.

There are all kinds of fancy ways to value a business (many of the m which overvalue it and many of them provided by accountants!), but to me it is immaterial if there is no actual buyer willing to pay that price. I agree with the article below to the extent that many valuation models are not realistic and not a true market value.

They have an interesting take on how to value a company that will most likely help you see things from a different perspective and maybe push your efforts in a new direction. At the very least using their valuation method may open your eyes to some critical numbers in your business you hadn’t considered before.If you don’t have the ability to generate these numbers for your business, you should be calling your san diego bookkeeper right now!

I don’t think you could sell the business based on these numbers in most cases but it would certainly go a long way toward helping you justify a valuation at the high end of the more traditional scales when negotiating with a serious buyer.

PS– if you are interested in finding out the current market value of your business, and how to increase it, give us a call!

Measures like Price-Earnings Ratio and EBITDA multiples are just gross generalizations of the value of your business. Here’s how to determine the real value.

Estimating the value of your business is usually calculated through measures such as earnings, EBITDA, and “comp” multiples. But if you’re trying to maximize the value of your business, the most accurate metric is customer value. Specifically, the value of your business is best measured by the aggregate value of your customers.

Finance theory tells us that the value of your business is equivalent to future cash flows, discounted back to today at the cost of capital. This is true. But how do most bankers, valuation experts, and business owners arrive at this valuation? They typically take the most recent year’s cash flows, or an average of the prior few years’, and project them into the future.

This is simplified further by use of “multiples,” or a multiple of current year cash flows used to approximate the present value of future cash flows. Since cash flow varies greatly from year to year at most businesses, EBITDA (earnings before interest, taxes, depreciation, and amortization) is often used as a more stable proxy for operating cash flow.

But as a CEO or business owner, you don’t need this level of accounting precision to value your business. You understand that your business is worthless if customers are not willing to pay (and continue to pay) for your product or service. Fortunately, you can use this concept to calculate the value your business. Here is the basic concept:

  1. Calculate the lifetime value (or more specifically, the estimated future cash flow) of each of your customers or customer segments. Follow the methodology we outlined in our recent article.
  2. Estimate the value of entering new customer relationships or customer segments, then discount the figure by a large factor, say 20 percent, to adjust for the probability of success.
  3. Add the value of each customer or segment, including the discounted value of potential new customers.

For most businesses, this figure will closely approximate the value of your business. For high-growth businesses, where current year cash flows are not a driver of future cash flow potential, this may be a better methodology. Surely, Facebook and Groupon are not being valued in the financial markets based on current year cash flows. Instead, analysts are calculating the potential value that their current and future customer base could create.

More importantly, valuing your business based on the value of customers is actionable. As a management team, it’s easy to see how to improve the value of the business by improving the value of your customer base. This calculation helps get you there.

 

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