Written on the 21 October 2013 by Queensland Government
Part 1
Select a Method for Business Valuation
by Queensland Governmemt
There are a number of methods used to value a business. No one method is more valid than another, and valuations are usually based on a combination of methods.
The 2 most common valuation methods are:
1.calculating a business's net worth (i.e. assets minus liabilities)
2.valuing based on the business's income or profits and the expected return on investment (ROI).
Valuation based on net worth
The net worth of a business is essentially the difference between what it owns (assets) and what it owes (liabilities). Assets minus liabilities equals net worth.
When calculating a business's net worth, you need to consider both tangible assets (such as machinery and equipment) and intangible assets (such as goodwill and intellectual property).
Drawbacks of this method are that valuing a business's intangible assets can be difficult. Additionally, it doesn't take into account the premium that might be justified for strong growth businesses or discounts for businesses that are in decline.
Part 2
Valuation based on annual net profit
Some people prefer to value businesses based on a business's annual net profit. Many industries have a ratio for valuing a business in this way. For example, the marketplace may value a particular type of business - as long as it's secure - at 3 times its annual net profit. However, a less secure business in the same industry might sell for only twice the annual net profit.
For example, let's consider a business in a particular industry that has a net profit of $50,000. If the standard valuation for this industry is 3 times net profit, the business value will be $150,000.
The drawback to this valuation method is that is doesn't necessarily take other factors into account such as an increasing or decreasing target market. For example, consider 2 businesses, each showing a net profit of $60,000 annually. If businesses in this particular industry are selling for twice the annual net profit, both businesses will be valued at $120,000. But if one business is experiencing increasing annual net profit, this method of valuation doesn't recognise it.
At this point in your valuation of a business, you'll usually need to select a valuation method or combination of methods. It's usually a combination of methods that the marketplace uses.
