Several valuation formulas can be employed to determine the value of a business. Here are ten of the most common formulas to value a business:
1) Asset-Based Valuation
The valuation formula for an asset-based calculation is:
Current Value = (Asset Value) / (1 – Debt Ratio)
Business owners often overvalue or undervalue their company when determining its worth.
To quickly value a business, find its total liabilities and subtract them from its assets. This will give you an idea of its book value.
This formula estimates the value of a business by assessing its assets and deducting any liabilities.
2) Income-Based Valuation
The valuation formula of income-based calculations is:
Present Value = (Annual Income/ 1+ Discount Rate ^ (1/ number of years)
This approach looks at the business’s income and estimates its future value. It then discounts that value back to the present to find the current worth.
If you are considering selling your business in California, the income valuation method is often employed by companies with a stable and predictable income stream.
Such businesses are typically valued at a multiple of their earnings, ranging from four to six times their annual earnings before interest, taxes, depreciation, and amortization (EBITDA).
3) Market-Based Valuation
The market-based calculation for a business’s current value would be:
CV = (EBITDA x 1.5) – (current liabilities x 0.5)
This formula is best used for service-type companies with a service business model.
V = (EBITDA * 1.3) / (Revenue – COGS) | For a trading/retail business valuation
This formula is best suited for a trading or retail business, as inventory is a current asset.
This formula examines what similar businesses have sold to determine the current market value.
For example, if you own a business that is similar to one that was recently sold for $1 million, then you can assume that your business is worth around the same amount.
4) Discounted Cash Flow Valuation
The discounted cash flow calculation for a business is as follows:
Value = (Future Cash Flow x Discount Rate) / (1 + Discount Rate)^n
Where:
Future Cash Flow = the estimated cash flow for the business at some point in the future
Discount Rate = the rate at which you expect to discount future cash flows back to the present
n = the number of years you expect to wait before receiving those cash flows
This approach examines the estimated future cash flows of the business and discounts them back to the present to determine their current value.
Although this calculation may seem like an oversimplification, it can provide a quick estimate of your business’s potential value.
Especially if you are looking to put it up for sale, this is a sample of what potential buyers might use as a starting point in their negotiations.
5) Equity Multiplier Valuation
The equity multiplier calculation for a firm is as follows:
Equity multiplier = current value/earnings before interest, taxes, depreciation, and amortization (EBITDA)
This formula calculates the amount of money stakeholders have invested in the company and multiplies it by a specific factor to determine its current value.
To calculate the equity multiplier, simply divide the business’s current value by its EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
This will provide you with a number representing the amount of equity invested in the company.
The higher the number, the more equity has been invested, and vice versa.
Investors often use this formula to determine whether a company is overvalued or undervalued.
6) Book Value Valuation
The valuation formula for a book value calculation is:
Book Value = (Beginning of Year Assets – End of Year Assets) / (End of Year Liabilities – Beginning of Year Liabilities)
This approach assesses the company’s assets’ value based on their historical costs. It does not account for any appreciation or depreciation that may have occurred since then.
This is how to calculate the book value of a business:
To calculate the book value, simply subtract the liabilities from the assets. This will give you equity on the balance sheet.
Next, divide this number by the number of shares outstanding to get the book value per share.
If you are planning to exit your business, buyers often use this formula to lowball your price.
To avoid this, ensure you have a clear understanding of your business’s market value before engaging in any discussions.
7) Liquidation Value:
The liquidation value calculation is as follows:
Liquidation value = Current liabilities – Value of assets
This is the amount that would be received if the company were forced to sell all its assets immediately. It does not take into account any outstanding liabilities.
No business owner wishes to liquidate the business, but it’s a method for calculating a company’s value.
To avoid using this valuation method, keep your business running smoothly and try to avoid any financial difficulties.
8) Break-Up Value
The break-up value calculation formula is:
(Asset Value + Liability Value) – (Total Debt) = Business Value
The break-up value calculation is a more comprehensive valuation that accounts for the value of a business if it were to be sold in pieces.
This calculation is used when a business is considering a sale, but the owner wants to ensure they get the best possible price for each asset.
The formula takes into account the value of the business’s assets and liabilities and then assigns a value to each component.
This is the amount that would be received if the company were broken up and sold off in pieces. Again, it does not take into account any outstanding liabilities.
This valuation method can also be used when a business is considering a merger or acquisition, such as in the case of a sale or acquisition.
This scenario will show you how to calculate the break-up value of a business:
For this example, we will assume that the business has assets valued at $1 million and liabilities valued at $500,000. The total debt of the business is $250,000.
To calculate the break-up value, simply subtract the total debt from the sum of the assets and liabilities. This will give you the value of the business.
In this example, the break-up value would be $1.25 million.
Acquirers often employ this valuation method to ensure they receive a fair price for their investment.
9) Peer Group Analysis
The formula for a peer group value calculation is:
Value = (1/N) x SUM(Pi*Vi)
Where:
N = the number of companies in the group
Pi = the market capitalization of the company i
Vi = the value of company i
This approach compares a company’s financials against those of similar businesses to estimate its worth.
A simple walkthrough of this business valuation formula would be as follows:
Say there are 10 companies in the group, and company A has a market capitalization of $1 million. Company B has a market capitalization of $2 million, and so on.
To calculate the value of company A, simply take 1/10th of the sum of all the companies’ market capitalizations multiplied by their respective values. In this case, the value of company A would be $100,000.
Who Uses this Valuation Calculation and Why?
Both investors and analysts use this valuation method to compare companies against their peers.
It’s a helpful way to value a company if you want to know how it compares to its competitors.
It’s a good way to determine whether a company is overvalued or undervalued relative to its peers.
10) Precedent Transaction Analysis
Precedent transaction value calculation =
(1 + r) ^ (t/2) – C
Where:
r = the weighted average cost of capital (WACC)
t = the number of years until the sale
C = the cash flow in the last year of the projection period
This formula examines the recent sales of businesses similar to the ones being valued to determine an estimate of their worth.
Suppose you own a construction company in the HVAC niche and are looking to use the precedent transaction value calculation to value your business.
In this case, you would look at the sales of similar businesses in the same industry and region to come up with a valuation for your company.
This valuation method is often employed by investment bankers and private equity firms when considering an acquisition.
Venture capitalists also use it to value startups that are in the same industry as companies they have previously invested in.
This valuation method is a suitable approach for valuing a company if you have access to data on recently sold similar businesses.
It’s also a good way to value a company if you’re looking at investing in an industry that you’re not familiar with.
5 Best Valuation Formulas to Determine the Value of a Private Company
When valuing a private company, several formulas can be used to determine its worth. The most common valuation formulas are the capitalized earnings, the discounted cash flow, the relative valuation formula, the enterprise value-to-EBITDA multiple, and the asset-based approach.
Let’s examine each one to determine the best calculation that works for you.
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Capitalized Earnings Valuation Formula
Capitalized Earnings = net income x (1 + WACC)^5
where:
Net income = the company’s last 12 months’ earnings
WACC = weighted average cost of capital
This is how to calculate capitalized earnings.
You take the company’s last 12 months’ earnings and multiply them by (1 + WACC)^5.
The capitalized earnings valuation formula is a suitable method for valuing a company when comparing it to other companies in the same industry.
It’s also a good way to assess a business if you’re considering investing in a company for the long term.
Selling a business can require extensive preparation and take years to finalize. This is an example of a business valued at $1 million by calculating its capitalized earnings.
First, you find the company’s net income. Let’s say it’s $100,000.
Then, you find the weighted average cost of capital. For this example, let’s say it’s 10%.
Now you plug those numbers into the formula:
$1m = $100,000 x (1 + 10%)^5
This formula is a suitable approach for valuing companies that are growing rapidly and have significant potential for the future.
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Discounted Cash Flow Valuation Formula
Discounted Cash Flow Value =
Cash Flow / (1 + Discount Rate) ^ Time Period
Where:
- Cash Flow = the company’s free cash flow for the next 10 years
- Discount Rate = the weighted average cost of capital
- Period = the number of years in the future
This is how to calculate the discounted cash flow value.
You take the company’s free cash flow for the next 10 years and divide it by (1 + the weighted average cost of capital) ^ the number of years in the future.
The discounted cash flow valuation formula is a suitable method for valuing a company when considering an exit from business ownership or when a prospective buyer is investing for the long term.
It’s also a good way to value a company if you want to compare it to other companies in the same industry.
This valuation is suitable for business owners who plan to sell their company within the next 2 to 5 years.
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Relative Valuation Formula
The valuation formula for a relative value calculation is:
Value = (Earnings Before Interest and Taxes) / (Interest Expense + Tax Rate)
Where:
- EBIT = earnings before interest and taxes
- Interest Expense = the company’s interest expense for the last 12 months
- Tax Rate = the company’s effective tax rate
This formula is a valuable method for valuing companies within the same industry.
It’s also a good way to value companies that have similar business models.
Let’s say you are a manufacturing business owner looking to maximize the value of your manufacturing business.
The first step for this example is to find the company’s earnings before interest and taxes (EBIT), which is $1 million.
The next step is to find the company’s interest expense for the last 12 months, which is $100,000.
Now you need to find the company’s effective tax rate, which is 30%.
Now you can plug those numbers into the formula:
$1m = $1 million / (0.3 + $100,000)
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Enterprise Value to EBITDA Multiple Valuation Formula
The enterprise value to EBITDA multiple value calculations are as follows:
- Enterprise Value = (EBITDA x Multiplier)
- Multiplier = Enterprise Value/EBITDA
Where
- EBITDA = earnings before interest, taxes, depreciation, and amortization
- Enterprise Value = the market value of a company’s equity + debt – cash
If you are in the transportation industry, this calculation can be highly accurate when determining the value of your trucking and logistics company.
This is an example of how to use the enterprise value to EBITDA multiple valuation formula.
In this example, we have a company with a value of $1 million.
The company has an EBITDA of $100,000.
The enterprise value-to-EBITDA multiple is 10.
So the enterprise value would be $1 million x 10, which equals $10 million.
This valuation is suitable for business owners who plan to sell their company within the next 2 to 5 years.
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Asset-Based Valuation Formula
Asset-based value calculation:
Value = assets – liabilities
Where:
- Assets = the total value of all the company’s assets
- Liabilities = the total value of all the company’s liabilities
This valuation is suitable for business owners seeking a quick and easy valuation of their company.
If your business has $ 200,000 in assets and $ 50,000 in liabilities, it is worth $ 150,000.
Final Take
There are various methods for valuing a company. The key is to use the proper method for your specific situation.
If you’re a business owner looking to sell your company, you should use more than one of the valuation methods to determine your company’s worth before putting it up for sale.
If you need help with determining your company’s worth, schedule a free consultation with Andrew Rogerson. He can help you determine the best way to value your company and maximize its value.
Business Valuation Resources
- How To Increase Company Valuation? 4 Value Drivers You Need To Know
- What is Quality of Earnings Analysis: Sell a Business Due Diligence in California
- Adjusted Financial Statements When Selling a Business in California
- SDE Adjustments To Make Before Selling a Business in California
- How Do I Calculate The Value Of My Business To Sell In California
- What is My Business Worth? | Valuing and Selling Your Business
- How Much is a Business Worth to Sell? | Determine Business Worth
- Income Approach Valuation | Finding Business Worth Easily
- How To Value A Business Quickly: Best Business Valuation Formula
- Seller’s Discretionary Earnings (SDE) Valuation | Selling a Business in California
- Financial Due Diligence When Selling a Business
- Income Approach Business Valuation Formula
- Market Approach Business Valuation Formula
- Small Business Valuation Multiples
Do you have any questions about valuing a company? Send them through.
Conclusion
Using the best valuation formula to determine the worth of your biggest asset, as well as the decision to exit business ownership, is a significant life event. Plus, there will be plenty of emotions.
When you collaborate with a business brokerage firm in California, it will provide all the solutions and insights necessary to get the most out of the business sale.
There are only a few ways to sell and value a business quickly in California, and an experienced business broker like Andrew Rogerson can guide you through the best strategy.
It is currently the perfect storm to value and sell your business in California.
With a certified business intermediary by your side, we are confident that you will sell your business in California quickly and at the highest possible price.
Andrew Rogerson is a certified business broker based in Sacramento, California. Call Toll-Free at (844) 414-9700 or email him at support@rogersonbusinessservices.com to service the whole state of California.
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