How are businesses valued when being sold?

| Jul 14, 2019 | Business Law

Even if you don’t plan on selling your business any time soon, it still helps to know its value. When retirement finally comes, you want to ensure you’re getting the best value for your business’s worth. There are actually three different valuation methods you can use, each of which may uncover some illuminating information. The Balance explains the different ways that a business’s value can be determined. 

Earning value

This process looks at a business’s future earning potential when calculating the value. This entails applying a formula that takes into account past earnings and factors in unexpected occurrences that could potentially impact earnings. This figure is subject to a capitalization factor, which is based on a business’s success and what can reasonably be expected from its future earnings. In this sense, businesses that have sustained success for a longer period will receive a more favorable capitalization factor than those that are new or have experienced trouble. 

Market value

This method takes into account the recent sales of similar businesses. By establishing market value, a buyer can reasonably be assured of a ballpark figure when it comes to earnings. This might not be a good option for all owners, however. Making comparisons can be difficult, either due to lack of competitors or because of its status as a sole proprietorship. 

Asset-based value

Asset-based valuations are a bit more concrete since they look at a business’s existing assets and debt. The liquidation method determines value by calculating how much a business would garner if all assets minus debts were sold. You can also look at a business’s current financial reporting and deduct the costs for any money owed to others. Other factors can also affect a business’s value, some of which are hard to anticipate. That’s why combing valuation methods is often recommended.