Know how much your business is worth

Know how much your business is worth

We build businesses and nurture them until they grow into conglomerates but we never stop to examine how much that business is worth. We need to evaluate how much our businesses are worth.
From the time of inception up to now you need to review and track how much your business has grown. There is constant change in the economic, competitive and regulatory landscape in which your business operates and this does affect the value of your business.
Reviewing the value of your business on a regular basis will allow you to have a firm grasp on the business’s current value and you will also be able to track the growth of the business over a period of time.

You need to identify whether the business is growing, whether it’s stagnant or declining. When you know the trajectory your business growth is taking you can adjust your business plans to focus more on the drivers of value so that you achieve the value you are targeting and you will also be in a better position to take advantage of opportunities.
You can use this value as a basis on which to develop value enhancing strategies to improve the profitability of the business as part of an exit strategy in the future.

There are a number of factors that might drive you to value your business. If there is a dramatic event that impacts on the business this might call for the business to be valued.
Events like acquisition of a big client, or a substantial increase in revenues or the entering of a new business partner can influence the value of the business, so it’s critical at that stage to know the value of your business to determine your next moves.

You might also need to know the value your business if something significant has happened to your personal life. Such events as a marriage or divorce might require you to carry out a business valuation to determine marital assets to include in your relationship or as part of marital settlement.
If you want to sell your business or you want to invite a partner in the business, it will be advisable you value your business so that you will have a fair value of the business. This value will act as a starting point for negotiations. You should see this value just as a price guide. At the end of the day it is very important to remember that the worth of any business is a result of the negotiations between a willing buyer and a willing seller.

But valuation is very important because it gives the seller or the buyer the fair value of the business and thus helps in negotiations.
Sometimes you might have to value a business to enable negotiations on how to split the business when there is a shareholder or partnership dispute or when one of the shareholders or partners wants to disinvest from a business.

You might also have to value a business if it is bankrupt and it has to be sold. The method of valuation will obviously be different from the one used on a business that is still operating.
In some cases you will have to value your business for insurance purposes. In that case you’ll need to know the value of your business so that you can determine the proper amount of insurance coverage required.

When you are about to retire it will be the right time to know the value of your business so that you can determine how much you are likely to get out of that business as part of your retirement.
Knowing the value of the business if you have to dispose of it will also help you assess whether the income from the disposal will be adequate to cover the life style you envisage after the retirement.

You could also use this value for estate planning. As a business owner you need to plan how your family will cover estate duty when they share your assets after your death. Knowing the value of your business will help you to calculate the expected estate duty and therefore provide for it in advance before you die.
If a company wants to list on the stock exchange to raise additional capital it has to value the business to determine the listing price. The business owners will need to determine the offer price they will use when launching initial public offering.
Assigning a value to a business can be very subjective especially for a private and young company. However, for listed companies you can use the market capitalisation which at least makes it objective. There are two major techniques that can assist us in valuing a business. You would need professional advice to get these valuations right.
The mostly understood valuation technique is the net asset valuation method. With this approach, all the company’s assets on the balance sheet are added up and all debts are deducted giving a net asset value.

With this method, you might have to adjust your asset values by calculating the estimated resale value of assets. You will need to analyse your inventory for any obsolete items and reduce the amount by these figures.

On accounts receivable or debtors you have to adjust for any bad debts so that your figures represent the realisable value of these assets. This asset valuation method often results in the lowest value for your business because it assumes your company is being liquidated and therefore does not have any goodwill.
Goodwill is defined as the difference between the business’ market value, (what someone is willing to pay for it) and the value of your net assets. Determining goodwill can be a complicated process because it can include: customer loyalty and relations, brand recognition, staff performance, customer lists, reputation of your business and business policies and operation procedures.
The asset valuation method can be modified by inclusion of intangible assets like intellectual property which would include patents and trademarks. These have a value. You will have to use a lot of subjectivity in determining a value for such items. You also need to include the value that you place on employees.

The value of most companies is in their people especially critical skills like full-time programmers or engineers for an IT business. Sometimes the founders and some executives might have to forego salaries as the business is growing, such sweat equity should be included in the valuation of the business.
And lastly the other adjustment you have to make to the asset valuation would be the value of customer relationships. Every customer contract is worth something so you need to assign a value to such.

The second method of valuation is the income valuation method or multiple earnings method. This involves projecting a company’s future cash flows and discounting them, at a certain discount rate which is determined by the risk free rate plus some premium to cover risk.
In this method, the seller or acquirer will be estimating what the future streams of cash flow is worth to them today. The more stable and predictable the cash flows are the more years of future cash that will be considered and this will more likely give a reasonable valuation.

In this valuation method the main drivers in determining the value of the business are how much profit the business is expected to make in the future and how reliable those estimates are.
The variation of this valuation approach involves averaging earnings for a number of years and then multiply this figure with a certain multiple to get the value of the business. The company’s earnings will be earnings before interest, taxes, depreciation and amortization commonly referred to as EBTDA.
Deriving the multiple in publicly traded companies can be done by taking the market capitalizations of similar companies in the industry and divide by the EBTDA to arrive at the price earnings ratio and this multiple can then be used to value the business.

The two values arrived using the two methods above can be used in negotiations if the business is to be sold or a new partner is to come into business. In some cases you can use the average of the two valuations.
“Be sure you know the condition of your flocks, give careful attention to your herds.” Proverbs 27 v 23.

l Stewart Jakarasi is a business and financial strategist and a lecturer in business strategy (ACCA P3), advanced performance management (P5) and entrepreneurship.
He is the Managing Consultant of Shekina Consulting (Pty) Ltd and provides advisory and guidance on leadership, strategy and execution, corporate governance, preparation of business plans, tender documents and on how to build and sustain high-performing organisations.
For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: sjakarasi@gmail.com, call on +266 62110062 or WhatsApp +266 58881062

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