How to Calculate Business Valuation: Manufacturing Business
The first step to take when selling your manufacturing business is learning how to calculate business valuation to determine your business’ worth. Below you can find more information on how to calculate business valuation.
How to Calculate Business Valuation?
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 use three approaches to calculate company worth: the Income Approach, the Market Approach, and the Asset-Based Approach.
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 the earnings of the company before selling.
EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization. It standardizes the company’s value by adding the interest, taxes, depreciation, and amortization expenses to the net income earnings.
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 are unique money-spending decisions that the previous business owner made and are not entirely the decisions the new owner will make. They include things like 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 assets.
Tangible assets include items like real estate, furniture, and cash, while intangible assets include 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 the liabilities from that of the 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 will tell you the value of a tangible item like real estate, no number can place a value on an intangible item, like a company’s branding.
Therefore, this makes it difficult to determine the value of some of the intangible items and can lead to an incorrect business evaluation.
Also, the value of some intangible assets like trade secrets and trademarks can change depending on timing.
Because of these two factors, the company’s net asset value is adjusted to determine the correct value of the company.
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 fit everything that the company could potentially sell for. This includes not only intangible assets like 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 the factors to increase value are all great ways to stay on top. Get a justified calculation for your manufacturing business.
Here are lessons from California manufacturing business owners.
Go to the next article: Part of tips to selling a manufacturing business in California series ->