How To Determine Business Value
Even though financial data plays a large role in determining a business’s value, it’s really only a starting point. In most cases, “value” is synonymous with quantifying the future returns to an owner or investor. Alone, financials tell an incomplete story of the past, and we’re left asking countless questions in order to determine how a business got to where it is today and where it’s going in the future. Therefore, to understand what your company is truly worth and to accurately forecast its future returns, we’ll use a combination of your financial data as well as other information.
Look Beyond The Profits
The first step in understanding a business’s value is understanding the business itself. What is your company’s competitive advantage? Are certain customers vital to the continued success of your business? What strategic opportunities do you plan to pursue?
To determine the answers to these questions, it’s imperative that we to speak with those who know the most about your business – and nobody knows the business better than its owners and key employees.
Quantify The Unquantifiable
Talking to owners and key employees within your organization provides us with vital information from a valuation standpoint. However, you’re probably wondering how we can boil all this qualitative information down to dollars and cents.
In theory, while it may be next to impossible to put a numerical value on individual pieces of qualitative information, it can be hypothesized that the aggregate value of these qualitative pieces is already incorporated in your business’s overall value. This is true if we derive value solely from historical financial results because, ultimately, it’s a culmination of qualitative factors that have led to these quantitative results.
Even so, this method of thinking is correct only to an extent.
Value-based solely on historical financial information would only be appropriate if you could guarantee your business would perpetuity perform as it has historically. But, with so many social, economic and political changes taking place at any given moment, it’s impossible to guarantee that anything will ever remain the same.
A valuation and transaction professional will take into account how these intangible elements will play into your business’s competitive environment and overall economic conditions. As a result, qualitative information will be translated into quantitative forms of measurement, which ultimately help us predict how your business will likely perform going forward. Depending on the information collected, this new quantitative data could ultimately impact the business’s overall profitability, growth and risk level.
You’re probably wondering why you should even care about these types of mathematical questions. As a business owner, you’re responsible for making critical business decisions every day. Oftentimes, these decisions will play a major role in determining your business’s future. When you understand what factors ultimately drive the value of your business, you can keep them in mind as you go about your daily decision-making, which will put your business in a better position for future growth.
Do You Know The Value Of Your Business?
You might think you already have a pretty good idea about how much your business is worth based on one method or another. Don’t be fooled. Such a mindset can result in valuation issues consistent with endowment bias (the tendency to value an asset more just because you own it). If you plan to sell your business one day, the value will likely be determined by an independent external source to ensure that the price point is fair for all parties. Rea & Associates can help you identify the true value of your business and provide you with information that can be used to help you make better, more strategic decisions. If you’d like to learn more about our valuation and transaction advisory services, feel free to reach out to me anytime.
By Paul Weisinger, CPA/ABV, CVA, CEPA (Cleveland office)