Understanding the value of your small business

Putting a value on your small business can be tricky, but it is essential to know the true worth of your business in order to make an accurate exit plan.

What is your business worth? Setting a value for your business is one of the biggest challenges a business owner can face. Often what you think your business is worth may not be the same as the amount someone is prepared to pay for it. Both parties want the best deal but if a business owner has an inflated notion of their business’ value then they are bound to be disappointed.

To get an accurate picture of what your business is worth you need to consider a number of factors including your business’s financial position, its physical assets and goodwill.

Ensure your paperwork is in order

Be prepared

Anyone interested in purchasing your business is going to want a valuation that is backed up by paperwork, so it’s important you have all your ducks in a row. Make sure all your business documents are organised and up to date. This includes cash flow statements, your profit and loss projections, annual turnover and any debts.

If your business has any physical assets – you own the building, you have the essential equipment, there is existing stock – then these should also be included. Don’t forget to include details of any other assets such as goodwill or any intellectual property (IP). Other important documentation that a prospective buyer might request include leases, registration papers, licences and permits to ensure your business meets government requirements.

Now you have all your paperwork in place it’s time to get into the nitty-gritty of valuing your business.

You can use ROI to value your business

Market value and return on investment

There are a few different methods you can use to value your business. Firstly, you can look at the marketplace value of your business. To determine this, you need to consider the industry you are in. If your industry is expected to grow in the future, that’s good news. Research business sales in your industry in your area. Check out the Australian Bureau of Statistics (ABS) for statistical data grouped by industry to see how the economic conditions of the business are faring.

Similarly, you can use the return on investment method (ROI) to calculate a value for your business. Return on investment uses your business’ net profit to work out the value of the business.

ROI = (net annual profit/ selling price) x 100

If you have a specific ROI in mind, then you can use this calculation to set the price.

Selling price = (net annual profit / ROI) x 100 

Assets come in all shapes and sizes

Don’t forget your asset

The value of your business also includes any tangible and intangible assets. What’s the difference? Tangible assets are physical assets such as equipment, tools of trade and property. While intangible assets include goodwill, client databases and intellectual property (IP) such as trademarks.

Don’t forget, some physical assets depreciate. You may have bought that computer for $2000 two years ago – but what is it worth today? If you’re uncertain how to work out the depreciation on your assets you should speak with your accountant to help you come up with a figure. Of course, one of the hardest assets to calculate is goodwill.

What does this mean exactly? Goodwill can include customer loyalty and brand recognition. Don’t forget to consider the length of time your business has been in operation when calculating goodwill.  A business that has been open for a decade will have established and loyal clientele compared with a business that may have only been in operation for a year.

Add up the assets of your business and subtract the liabilities and voila! You have an asset value for your business.

What would it cost to build your business from scratch?

Benchmark your business

What would it cost you to open an identical business from scratch? Sometimes estimating the costs to start your business in the current market conditions can also give you a good idea of the value of your business. To calculate the cost, you’ll need to include buying equipment and tools, licences, permits, purchasing or leasing premises, buying stock, setting up online and social media, marketing and promotion, recruiting and training staff, staff wages and any product development… Phew!

 Future-proofing is key to success

Look to the future

Any prospective buyer is going to be most interested in the future earnings of your business. If you can give a buyer a clear idea of a secure financial return, then they are more likely to pay the asking price for your business. Examine your existing finances to look for any trends and forecast any future profits. You should also check industry indicators for predictions of how your business may do in the current/future market.

 Have an exit plan and dont settle for a low price

Don’t be forced into a sale

Unless circumstances (such as ill health) force a sale, do not sell your business under pressure. A forced sale can drive down the price you will receive. In general, the longer you have to sell your business the more likely you are to get a good price.

What now?

Speak to an expert. Talk to your accountant about your business valuation check out for more information.

Does your small business have not-so-small ambitions? Head to NAB to find more info, tools, articles and tips to help you achieve your business goals.

The information provided in this article is intended to be of a general nature only

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