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How to value a small business

R A Valuation Services Limited specialises in providing sensibly and competitively priced business valuation and company valuation reports for businesses and other organisations in the UK and Europe.

There is no single formula that can be used to precisely value every private business. In an open market prospective deal, the seller will want to drive the price up, and potential buyers will want the opposite.

Although there are relatively easy ways to value certain parts of the business - such as stock, fixed assets (land, machinery, equipment etc.), there will very inevitably be a sizeable intangible element to the value of a business.

Intangible elements include 'goodwill' - this is the going concern value of the business and can include trademarks, and the reputation of the company. Such assets are notoriously difficult to value, and will require specialist help.

When looking at the overall value of a business, there are a number of different valuation methods that are commonly used - from using earnings multiples, to calculating how much it would cost to create a similar business.

In this guide, we look at some of the most commonly used valuation techniques, and how other factors may influence the value of a business at any given time.

COMMON BUSINESS VALUATION METHODS:

Earnings Multiples

Quite often, multiples of earnings are used as a business valuation method. This method would be suitable for companies with an established financial history.

The Price/Earnings (P/E) Ratio represents the value of the business divided by its post tax profits.

The calculations appear relatively simple, however there is no standard P/E ratio figure that can be used to value every business.

Companies within certain industries, such as high tech and IT, will typically command a much higher P/E ratio than more common bricks and mortar businesses such as a retail business or an estate agency.

Businesses where profits are growing rapidly will also command a higher earnings multiple, than firms where profit growth is low.

With a small business, the market for the main product could disappear overnight, or the key executives might suddenly decide to leave. If either of these scenarios were to occur, and these things certainly do happen, company profits would tumble and the very existence of the business could be called into question.

A large company with hundreds of different products and thousands of employees, would be inconvenienced by losing a key product or a few important employees, but profits wouldn't be significantly damaged.

The higher risk of buying a small business is therefore reflected in a lower P/E ratio.

Entry cost

Quite simply, this is the predicted cost to set up a similar business to that being sold. This would include the cost of developing a customer base and reputation, recruiting and training staff, purchasing assets and developing products and services.

Asset valuation

This method is more appropriate for established companies with a high level of tangible assets, such as property companies. The valuation is made by calculating the net realisable value of all assets.

Discounted cashflow

This method uses an estimate of the company's cashflow over a certain period of time. The 'terminal value' of the company is also calculated after this period has expired. The value of the predicted cashflow, plus terminal value, is then discounted, to provide a current business valuation.

It may be hard to establish an accurate terminal value, as it relies so heavily on the cashflow estimates. This valuation method may be used when a company has a lot of potential, but few assets and little financial history to speak of - for example, an online business.

Industry valuations

In certain industries, when businesses change hands on a regular basis, industry-wide rules of thumb are sometimes used to value a company. Examples of such industries include recruitment agencies and accountancy practices.

Business Valuations
Can RA value any type of Business?
The valuation process can be applied to all types of small business provided that the business has a suitable trading history .... more >>

How does RA value a Business?
The valuation process is concerned, primarily, with an assessment of a justifiable value for goodwill .... more >>

What is R A Valuation Services Ltd?
Established in 1991, RA specialises solely in business valuation .... more >>


Reasons for a valuation
A Business Valuation supported by a professionally prepared valuation report from an independent and authoritative source is an essential aid to:
  • Management or internal buyout
  • Business sale / Business purchase
  • Partnership and shareholder change
  • Litigation e.g. legal separation
  • Incorporation
  • Tax agreement
  • Borrowing and funding
  • Business development
  • Benchmark / Performance indicators for business
  • Report is definitive & realistic in the market place
R A Valuation Services Ltd
Recognised Authority
Valuation reports produced by R A Valuation Services Limited are acknowledged to be the authoritative form of business valuation for many small and micro business sectors and are accepted by:
  • Bank managers
  • Other lenders & providers of finance
  • Lawyers
  • Accountants
  • Tax specialists
And an R A Valuation Services' valuation report is tailor-made for their purposes. Indeed, such is their authority that an R A Valuation Services' valuation report is normally insisted upon in support of negotiations.

The report itself is detailed and informative, professionally presented and smartly bound.

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