We know your small-to-medium-sized business is something you have worked incredibly hard to build. At DHJJ, our team members diligently deliver a complete range of services so you can achieve your professional goals and accomplish the things that motivated you to start your business in the beginning.
One of the avenues our staff uses to help you accomplish these goals is through routine business valuation. In this blog, we’ll outline everything you need to know about business valuation, helping you determine if a valuation would benefit your business.
What is a Business Valuation?
You may have heard the term business valuation before, or perhaps this is the first time you have really considered the concept. Generally, a business valuation is a procedure that business owners and their financial advisors use to determine the economic value of an entire business or company.
Importantly, economic value is the price a person, or, in this instance, a business owner, assigns to a good based on the profit or other benefits that they hope to derive from that particular good.
A business valuation is useful to determine the fair value of the business or company for a variety of purposes, including determining sale value, establishing partner ownership, taxation, and even divorce proceedings.
What is the Purpose of a Business Valuation?
As with any important business strategy, there are times when a business valuation is needed. Generally, a business valuation is initiated and directed when the business or company is anticipating a potential sale of all or some portion of its business operations or the business owner is considering a merger with another company or even the possible acquisition of another company.
Another reason you may benefit from a business valuation is if you are considering an investment to help balance the books during a slow season. If you have ever sought investors or financial backers, then you know there are certain assurances your potential investors will want to see before they agree to come alongside your business.
Through a business valuation, investors will be able to see the ongoing percentages of your profits. Providing these numbers will assist you in acquiring investors with a detailed, solid picture of your business.
You will also benefit from a business valuation when pitching to potential lenders. Lenders and banks provide loans, mandating some kind of collateral. When you approach a potential bank or lender to receive a loan to help you make a purchase, buy out a partner, or cover expenses during a slump, you will find having a current business valuation will make it easier for your potential lenders to review your file and make an informed decision.
Is Business Valuation Important?
Yes! A business valuation is important if you are considering a sale, merger, or acquisition. A valuation is vital to understand the economic value of your company and the companies that may become part of yours. You should also review the business valuations of other companies you may consider aligning your business with.
In addition to the business growth and the importance a business valuation has on that process, a business valuation is vitally important for taxation purposes. The Internal Revenue Service (IRS) mandates that a company or business is valued by its fair market value. A sale of the business, or a portion of it, or the purchase or gifting of company shares are considered taxable events. Without a business valuation, you could violate IRS requirements, unintentionally accruing penalties and fees.
How Does a Business Valuation Work?
There are dozens of different methods and approaches to accomplish a business valuation. We provide 3 efficient valuation methods here:
1. Book Value/ Liquidation Value
The book or liquidation value is one that some very successful entrepreneurs swear by. The book value is the net cash value your business would bring about if all of your assets were sold today and all of your liabilities were paid in full. Take a look at your balance sheet. This method permits you to see any blind spots you have in a valuation.
The benefit of this method is that, even if your business’ revenue falls drastically after the sale, merger, or acquisition, you can fall back on the book value.
2. Market Value Valuation
This is probably the most commonly understood method of business valuation. During a market value business valuation, your business is compared to other businesses of similar size and function that have sold recently. This is a pretty standard form of valuation, and it is similar to that of the real estate market.
The downside of this method of valuation is that you will have limited data if there are not many businesses with which you can compare your own, or if you are a relatively new concept and others like yours have not sold recently.
3. Earning Value
This method is based on the approach that a business’ value is found in that business’ ability to continue to produce future wealth. This method works by evaluating a business’ history. Upon business valuation, all of the company’s past earnings are compiled and all of the extenuating factors are removed, such as unusual circumstances, influx, or expenses. The annual income is then divided by the capitalization rate. For example, if your business had a net profit of $1 million annually, and the applicable cap rate is 20%, then you could make an estimate would be $1 million divided by 20%, which is $5 million earning value rate.
Ready to Talk About a Business Valuation For Your Company?
Most businesses can benefit from a business valuation at any time, but a valuation is especially important during periods of significant change for your company. At DHJJ, we provide business valuations geared toward the long-term fiscal health of each business.
If you are interested in learning more about what our team can do for your business, you can contact us by clicking here or calling 630-420-1360. An expert will respond shortly.
