How to Value a Business: 9 Ways to Calculate a Business's Worth Not sure how to value a business or calculate its financial worth? Discover nine ways to calculate a business's worth in this detailed guide.
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No two businesses are worth the same amount of money.
Whether you're a lender looking to decide whether a business is a worthwhile investment or want to know how much your business is worth before making a strategic exit, you need to know how to value a trade through several potential methods.
What is company valuation?
Company valuation is the science of determining the "true" value of an enterprise.
For example, when a startupentrepreneur wants to sell their business to move on to a new project, they need to be able to value their company so they can demand a reasonable asking price for the brand, its resources, and other elements.
Similarly, an investor may wish to value a company to know whether it will likely turn a profit and how much money they should offer the company's owner if they want to purchase it.
You can perform company valuation in a variety of different ways. In many cases, it's a good idea to calculate a business's value using several methods or formulas to get a holistic, comprehensive picture of an enterprise and its current value.
Related: Your Business and Its Value: How to Build, Grow, and Then Sell It
9 methods to calculate a business's value
Here are nine methods you can use to evaluate a business, whether for your organization or a company you are thinking of investing in.
1. Examine its "book value."
A company's "book value" is essentially its value on paper, usually determined by examining the information on a corporate balance sheet.
Examining a company's book value is a quick and easy way to calculate its value or worth. However, this method is unreliable and often imprecise due to its simplicity.
To calculate the book value of a company, subtract its liabilities from its assets (you can find both of these elements on a company balance sheet). That can help you determine the owners' equity.
Next, exclude any intangible assets owned by the company. The number you have remaining tells you the value of the tangible assets owned by the company.
Again, book value can be an excellent way to get a quick, bird's eye view of a small business's rough financial value. But you should never use this business valuation method by itself.
2. Perform a discounted cash flow analysis.
You can instead perform a discounted cash flow analysis. This valuation process involves estimating the value of the business based on the cash flow the organization is supposed to generate in the future.
Through the discounted cash flow method, you can determine the future value of the company based on its current cash flow and related factors.
The discounted cash flow analysis formula is:
- Discounted cash flow = Terminal cash flow / (1 + Cost of Capital) # of Years in the Future
You divide terminal cash flow by the expected capital the company will own several years into the future. This valuation method is beneficial because it reflects how well a company can generate liquid assets.
It's an excellent way to estimate the future cash flow or value of your business compared to its present value, which may be much higher due to predicted future earnings.
3. Calculate enterprise value.
Alternatively, you can calculate a brand's enterprise value. To determine enterprise value, you combine a company's equity and debt, then subtract the cash it doesn't use to fund its operations (essentially free cash).
Here's the formula for a more detailed picture:
- Enterprise Value = Debt + Equity – Cash
Say that you're looking at a company with a market capitalization of $50 billion. On its balance sheet, it has liabilities of $170 billion with a remaining cash balance of $11 billion. Plug those numbers into the formula, and you get $209 billion.
Enterprise value is an excellent way to get the raw financial value of an enterprise, but it doesn't tell you a lot about its inner workings, such as how much money it spends to make a profit. Appraisers should consider using enterprise value in tandem with other valuation calculators.
Related: Understanding a Business Valuation
4. Determine market cap.
Market cap or market capitalization is a simple and valuable means to determine the value of a publicly traded company. You can evaluate a company's market cap by multiplying its total shares by its current price. See this formula:
- Market Capitalization = Share Price x Total Number of Shares
For example, if a company has a share price of $50 and 10,000 shares, its market capitalization is $500,000.
Market capitalization, while effective, only accounts for the value of a company's equity. This can be a problem when performing a comprehensive analysis because most organizations are financed by equity and debt (such as loans and angel investments). Therefore, don't forget to use market cap in conjunction with other valuation methods.
5. Determine EBITDA for a company.
The Earnings Before Interest, Taxes, Depreciation and Amortization or "EBITDA" for a company is an excellent metric to analyze its overall financial worthiness, as it calculates its earnings before any deductions are made. You can also think of these as operating earnings.
While valuable for determining the cash flow power of an organization, EBITDA doesn't tell you the net profits or revenue of the company when accounting for everyday costs and associated expenses, so it's best used as just one part of a holistic financial analysis.
6. Calculate the value of a growing perpetuity.
A "growing perpetuity" is any financial instrument that pays a certain amount each year to investors or owners. But that payout also grows annually. Stipends for retirement are excellent examples.
You can use the growing perpetuity equation to figure out today's monetary value for a (hypothetically) growing financial investment. To calculate growing perpetuity, use this formula:
- Value of a growing perpetuity = Cash Flow / (Cost of Capital -Growth Rate)
Determining a company's value is a growing perpetuity to determine whether it will be an excellent long-term investment.
Related: How to Value Your Startup
7. Calculate the P/E ratio.
The P/E ratio or price-to-earnings ratio measures a company's current share price compared to its earnings-per-share, or EPS.
Also called the price multiple or earnings multiple, the P/E ratio lets you know how valuable a company's shares are relative to its raw or real-world value. Hence, it's a great way to value a company publicly traded on the stock market as an investor. You can also use this as a small business owner to demand a higher sale price from potential buyers for your business.
The P/E ratio formula is:
- P/E ratio = Market value per share / Earnings-per-share
You divide the current market value of a business's shares by the actual earnings those shares represent. When you do this, you can quickly determine whether a company is likely overvalued or undervalued on the stock market.
8. Add up its net asset value.
There are some more straightforward ways to calculate a business's worth. For instance, if you want to sell your enterprise for a reasonable price, you can simply tally up all the value of your net assets.
Add up the value of everything your business owns, such as:
- Business equipment and manufacturing gear.
- Available inventory.
- Real estate.
Once you do this, you'll have the net present value of your business, a figure representing how much money the company "has" in terms of its goods or raw materials. That can be a powerful bargaining chip when you attempt to get a reasonable price for your exit.
This is a great way to evaluate business if you're a startupentrepreneur looking to move on to your next business idea ASAP.
9. Determine liquidation value.
Last but not least, you can also determine the liquidation value for your business. The liquidation value is the net cash you'll receive if all sellable assets are sold and all your liabilities or debts are paid off.
Calculating liquidation value should be simple if you've already tallied up your net assets. Simply add up all of the business assets as you did above, then subtract any outstanding debts, like loans or invoices that have yet to be paid, to get your final number.
How can you value your business
You can calculate a business's worth by determining its liquidation value, examining its "book value," performing a discounted cash flow analysis, and using various other means.
Arguably, the best thing to do is utilize all of the above, or at least most of the above methods, then average out costs to have a big-picture understanding of a business's value.
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