How Do I Value My New Business? Our Accountants in Leeds Explain
Author: Russell SmithNovember 28, 2016
Our accountants in Leeds get numerous questions from small business owners, but one that regularly crops up is this: “how do I value my business?”
Getting a realistic valuation of your business is very important. If you are looking for potential investors or buyers, you must have some sort of understanding of the value of your business.
For example: how can you offer an investor 20% of the business for £50k if you have no idea if the business is actually worth the full £250k?
What is a Business Valuation?
A business valuation looks at how much money your business is actually worth.
In a financial entity like a small business, where you are making profit, there is an inherent value in that profit. Even if you aren’t profitable yet, but have the potential to make profit, your business has value.
In a business world dictated by the common phrase ‘cash is king’ — which basically means money above all else — having a value of your business is essential.
Business Valuing Tips to Remember
Before we get into the nuts and bolts of valuing a business, there are a few things that are well worth remembering.
- Capital is Not Part of Your Business’ Value: Some business valuation plans include capital as part of the overall worth of the business. This isn’t traditionally how a business is valued by investors, however, and including capital assets can lead to overvaluation. Claiming your business is worth more than it actually is can be dangerous, as business experts, investors, and potential buyers might think you are being egotistical or delusional.
- The Market Valuation is What Your Business is Actually Worth: In this blog, we will find a way to estimate your business value, as you can never truly know the exact numbers. However, the valuation we come up with here is a guess; the true value is what the market will offer. If you pitch to investors or buyers that your business is worth £500k and time and time again they refuse to accept this number, valuing it closer to £450k, they are right. A business is only worth what the market believes it is worth.
How Do You Value a Business?
Our team of accountants in Leeds follow the popular practice of evaluating a business’ value by looking at their current and potential profits.
The reason this method is popular among investors and buyers is that it gives them a real idea of the money to be made. That way, they can understand the risks they are taking and decide whether the investment of time and money is worth the potential payoff.
In order to value your business, we need to consider:
- Current Profits — annual gross profits since business began
- Expenses and Tax — the net total profits annually
- Your Salary — how much are you costing the business?
- Growth — any potential increases in annual revenue
Step-by-Step Business Valuation
The simplest way to understand how to value your business is to take an example.
Let’s say your small business made £80k in the last financial year.
We then have to consider the actual profitability of your year in business.
First, you have to consider your base salary. A big mistake when evaluating your business is not considering how much money you yourself take from the business. If you are attracting investors, you’ll still be working and taking money out. If you sell up, somebody else will have to be taking a salary too.
Pick a realistic base salary; you can always take the rest out in dividends, after all. Trying to drive the value of your business up by saying you take a base salary of £11,000 is the wrong way to go, because you will definitely be taking more in reality.
Pick a salary you can comfortably live on. Let’s say £30k from our £80k business.
Then, we have to consider taxes and other expenses. In our example, after everything is paid off, we are down £25k.
So in total, the net profit of our business is £25k.
Now we have to consider multiples. In business valuations, it is standard practice to multiply your base value anywhere between 5 and 10 for a small business.
It is anticipated that if your company is profitable enough to be worth investing in, it will be in business for years to come. A value of five is given to businesses that are very small or in a particularly tough niche. The value then increases based on the size of the business, market, and industry.
A little bit of research is required here to find the multiples used in your industry.
Our fictional business is given a multiple value of eight, which means we can settle on the value of £200k. Sounding better, right?
But we aren’t done there. This number isn’t the final value of your business.
Companies rarely keep the same profit line year after year. If your business is worth investing in or buying, it will not only be in business for years to come, but should be more profitable, too.
This is where we come in. Trying to figure out your market growth rate can be very complicated. It requires in-depth financial research and an expert knowledge in business. Our accountants in Leeds can do that for you, and a whole lot more.
Getting this number right is of key importance. Usually valued between one and six, it will multiply the value of your business again based on earning potential. If you don’t get the number right, you can seriously overvalue or undervalue your business.
Investors are also going to want evidence as to why you’ve chosen your number. You can try and figure this number out yourself, citing competitor growth, your business’ current growth rate, profit to investment ratios, and more. But, being able to say you’ve been evaluated by a financial expert is a real bonus and can inspire much more confidence in investors and buyers.
In our example, we’ve evaluated our potential growth rate and believe we can comfortably expect to be making increased profits over the coming eight years. Our valuation is a multiple of three, bringing our total business value to £600k.
This £600k is what we will tell investors and buyers our business is worth — and that is how you should value your business.