Business valuation methodology is the method that valuers use to put a monetary figure on your enterprise. In most cases, purchasers are looking at what the likely profit will be as they move forward, as well as the level of risk in continuing to achieve the profit.
If you have a small business, the group of assets transacted is typically the goodwill, stock, plant and equipment. The buyer will grab those business assets and put them into a new family trust or company entity.
If you’ve got a larger business, it may alternatively be a company transaction that includes the plant, equipment, stock and goodwill plus the net other assets on the balance sheet.
This includes assets such as cash in the bank and people who owe the business money and then on the other side, liabilities like loans and creditors.
Chris Milne, director of business valuations at Jarot Business Assessments, says most of us understand the basics of valuing a house we want to live in.
We use a comparison method where we look at sales of similar houses in similar areas. For a commercial investment property, we look at the income. When buying a business, it is primarily considered an income producing investment and therefore an ‘income method’ of valuation is most often used. The main ‘income method’ is known as capitalisation of future maintainable earnings.
The capitalisation of future maintainable earnings, is profit divided by a capitalisation rate (to measure risk). The capitalisation rate is established by looking at the risk profile of the business, and comparing it with similar businesses that have sold in the marketplace. Most small businesses in Australia are valued using this method.
Some specialised business are valued using measures that are different to profit.
For example, Real Estate Rent Rolls are valued via a ratio of cents in the dollar to the management fees. So, in WA, in late 2018, rent rolls typically sold at around $2.50 per dollar of management fees. Small accounting businesses typically sell on the accounting fee revenue, times a rate in the dollar. In WA in late 2018, small accounting practises were commonly achieving $1 per $1 of revenue. In these cases, a profit measure is not used.
Sometimes an ‘asset value method’ can also be considered, where a business’ main value lies in its tangible assets. An example of this is a trucking company where a lot of the value of the company is in the trucks and equipment.
These are Chris Milne’s suggestions when preparing for a business valuation:
- Check the method: Any valuation method should reflect what is most commonly used by participants in the marketplace. It’s no use having a theoretical valuation method that’s different from the way that the buyers selling, and brokers are assessing and transacting, in the marketplace.
- Check qualifications: Business valuations are a specialised area that is only done by a relative few. Your valuer needs demonstrated experience and qualifications in the area that you’re looking at. For instance, small business is different to large business and listed companies.
- It's more than numbers: “A lot of people have an idea that business valuations are about getting a set of accounts for the business and that’s all you need. But only 25 per cent of information is held within the financial accounts and 75 per cent is an understanding of how the business operates which comes from questions to the owners and managers of the business. “We (business valuers) need to understand how it operates and its risk profile,” says Chris.
- Refer to external resources including the Business Reference Guide (US publication) and local reports such as WA business broker GMO’s State of the Market Report and Jarot Business Assessments Business Values Newsletter.
