The first step to take when planning an exit of your manufacturing business in California is learning how to calculate business valuation to determine your business’s worth.
Below, you can find more information on how to calculate business valuation.
How to Calculate Business Valuation in California?
Calculating the valuation of your manufacturing business is a complicated process. If you are not a financial expert, you might end up undervaluing your company and losing money on the sale.
As such, we recommend you contact a professional advisor to determine your company’s value before selling. Moreover, a broker can also add value and increase the selling price tag for your business.
A Broker’s Price Opinion involves hiring a manufacturing business broker or a licensed business broker to evaluate the value of your company.
The broker or advisor will then use the valuation to determine your business’s Most Probable Selling Price (MPSP).
Brokers employ three business valuation approaches to calculate a company’s worth:
- The Income Approach,
- The Market Approach,
- and the Asset-Based Approach.
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Here are the steps you should follow when determining the value of your manufacturing company using the asset-based approach:
Step One: Calculate the SDE or the EBITDA
Before calculating business valuation for your company, you must first determine the SDE or the EBITDA of the business. The EBITDA and SDE are tools that standardize a company’s earnings before interest, taxes, depreciation, and amortization.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It standardizes the company’s value by adding interest, taxes, depreciation, and amortization expenses to the net income.
You can find EBITDA by using the formula below:
EBITDA = Net Income + Interest Expense + Depreciation Expense + Amortization Expense + Taxes.
SDE, on the other hand, stands for Seller’s Discretionary Earnings. It is used to standardize the business value by adding the business owner’s discretionary earnings to the net earnings.
These discretionary earnings represent unique money-spending decisions made by the previous business owner and are not necessarily the decisions the new owner will make. They include items such as the business owner’s salary, travel and entertainment expenses, and research periodicals.
Find the SDE using the formula below:
SDE = Net Income Earnings + Discretionary Earnings.
Step Two: Calculate the Value of Your Company
When calculating business valuation for your company using the asset-based approach, the manufacturing business broker evaluates the total value of assets and liabilities. Assets, in this case, can be tangible or intangible.
Tangible assets include items such as real estate, furniture, and cash, while intangible assets encompass goodwill, copyrights, trademarks, and patents.
After determining the total value of all the assets and liabilities, calculate the company’s value by deducting the liabilities from the assets.
One major setback of calculating asset-based value is determining the value of intangible assets. While you can find the value of tangible assets on company books, the value of some of the intangible assets is not.
Because of this, the value of the net assets is adjusted to get the correct value of the company.
Calculate Business Valuation: Asset-Based Formula
In the asset-based approach, the evaluation process includes calculating the value of the assets that the business has recorded in its company books. The most straightforward formula is to subtract the value of liabilities from the value of assets.
However, most of the time, the value of the assets minus the liabilities can differ from the values reported on the balance sheet. This difference can be attributed to two factors: difficulty in determining the value of intangible assets and timing.
While there is a number in the balance sheet that indicates the value of a tangible item, such as real estate, no number can accurately place a value on an intangible item, like a company’s branding.
Therefore, this makes it difficult to determine the value of some intangible items, which can lead to an incorrect business evaluation.
Additionally, the value of certain intangible assets, such as trade secrets and trademarks, can fluctuate depending on the timing.
Due to these two factors, the company’s net asset value is adjusted to determine its correct value.
Now, with the adjusted asset-based valuation, instead of using the balance sheet values to determine the value of the assets, we use the market value of the assets in the current environment.
The market value of the assets is adjusted to reflect the potential sale of everything the company could sell. This includes not only intangible assets, such as trade secrets and copyrights, but also the liabilities that will be subtracted from these assets.
Valuing a Manufacturing Company
Valuing a manufacturing company is no easy task, especially for the business owner. Arming yourself with the best approach, hiring a manufacturing business broker, and considering key factors to increase value are all great ways to stay ahead. Get a justified calculation for your manufacturing business.
Here are lessons from California manufacturing business owners.
Go to the following article: Part of the tips to selling a manufacturing business in California series ->