There are typically four main approaches to valuing a business in the UK - earnings multiple; net asset valuation; discounted cash flow; and recognised industry rules of thumb.
Earnings Multiples
For small trading businesses in most industries, however, the appropriate initial approach is applying an Earnings Multiples – a multiple of surplus, adjusted net profits or adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) to calculate the trading value i.e. before consideration of the its liquidity position, investments, excess assets or net debt.
Net Asset Valuation
Another way to value a small business is through a net asset valuation. This method is often appropriate for strong, stable businesses with plenty of physical assets (property and manufacturing businesses are good examples). Asset valuation can result in the lowest assessment of a business and, for small trading businesses, a net asset approach may not represent fair value.
Discounted Cash Flow
Although more typically used for investment into larger organisations or significant asset acquisition, a discounted cash flow methodology can be appropriate for valuations in connection with growth shares and freezer shares - especially for established businesses with predictable cash flows, such as energy companies.
To establish the value of a small business through discounted cash flow, the valuer will estimate today’s value of future cash flows. The assessment considers risk and the time value of cash. In short, time value is based around today’s pound having more value than tomorrow’s, owing to its earning potential. The discount interest rate tends to vary between 15 and 25 percent, though each assessment is reviewed on a unique basis.
In some sectors – such as where there are high volumes of business acquisition and disposal - it can be appropriate to assess a business based on industry rules of thumb.
We are happy to explain the process and what you would need to provide, so why not phone the office on 01425 402 402.
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