What Are Business Valuations?
A business valuation is a method that enables someone to determine the economic power or value of a business, a limb of a business, or a group of businesses. When undergoing a valuation, we are looking for a reasonably fair value that is a baseline value of your business. This helps make better decisions and set more informed goals. You’ll need to know the value of your organisation when you’re selling your business, trying to get finance to back your business, or arranging tax payments. You’ll even need to know this information if the business owner is implicated in matters of family law, such as divorce proceedings.
How Do You Work Out a Business Valuation?
Figuring out a business’s valuation is not an exact science. There are steps you can take to make a strict, accurate, and fair valuation which you can rely on with some confidence when talking to investors, potential buyers, or a court judge. Generally, there are a few basic rules to remember, and which we apply, when helping you work out your business valuations.
Whenever the business is up for sale, the buyer will always use a method of valuation that demonstrations that your organisation has a lower value than you may think, whilst as the seller, you will likely find a valuation method that demonstrates the value of your company is higher.
Which Method Does Numberslides Use to Value Your Business?
There are all kinds of ways to value a business. You can use discounted cash flows, multiples of EBITDA, perpetual growth, or Scorecard methodology. At Numberslides, we use the perpetual growth methodology. We aim to derive a Terminal Value of your business.
How to Calculate Terminal Value with Perpetual Growth Business Valuation
To calculate Terminal Value, we must start by calculating the Free Cash Flows to the business. These Free Cash Flows (known shorthand as FCF) are the cash flows that are left over after the business has paid off all its costs, expenses, and investments. Investments describe money spent to keep the business performing at its current level of operation.
Free Cash Flows are also known as ‘Unlevered Cash Flows’ because we are talking about cash flows that do not take into account any sort of debt finance (which means we are using someone else’s cash outside of the business’s own).
The perpetuity growth model assumes that cash flows grow at a constant rate continuously and infinitely.
The Terminal Value (TV) is today’s value or the present value of all future cash flows. We work this out with the assumption of perpetual stable growth. This is the basis for your business valuation.
The formula for working out Terminal Value and Perpetual Growth is:
Terminal Value = Unlevered FCF in the terminal (exit) / (discount rate – long term Growth Rate)
The Terminal Value that we produce using this formula includes the value of all future cash flows, even when they are not considered in a particular forecast period. This enables us to capture certain values that can be difficult to predict.
Which Perpetual Growth Rate Should You Choose?
When working out your perpetual growth rate, note that this rate is almost always equivalent to the inflation rate, and less than the economy’s growth rate. In acknowledging this, we must also acknowledge that this type of business valuation does have its limitations. As it is difficult to predict an accurate growth rate, we always choose the more cautious approach.
How Can I Increase the Valuation of My Business?
So, you’re numbers have come out pretty rubbish. Perhaps you’ve been a little over cautious. There are two things you can do to shake up your predictions.
- Switch up the cash flow; more specifically, look at the way your company currently generates cash flow; is there any way that you can improve that ability? Can you perhaps increase revenues or reduce some of your expenses?
- Reduce the company’s risk; any reduction of risk lowers the business’s cost of capital and will therefore increase value.
If you make these changes and still don’t see a significant improvement in the numbers then it may not be enhancing value.
Is there a particular valuation model you’d like us to use? Contact us using the chat bot on your screen and let us know!
