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Cash is king!
Published August 2007
What’s your business worth?
The value of a privately-owned business is what someone will pay for it on a particular day. So valuations are opinions, not fact.
Also, factors unique to the buyer will affect what he is prepared to pay. If they have to relocate, service a higher debt and depreciate new plant, machinery or technology, he will offer less. They will also apply his own accounting policies when calculating the business’s profits, which can result in a significantly different profit figure from the owner’s.
This is the commonest method of valuing a smaller business. An adjusted post-tax profit is calculated, and a multiple applied, to arrive at a value for the business. ‘Adjusting’ means removing abnormal items in the accounts that won’t reoccur, such as costs of an acquisition, and one-off bad debts that have been written off.
The multiple for an owner-managed business is normally between one and three; for a business managed by directors on behalf of non-director owners, or with adjusted profits of up to £500,000, it is normally between three and seven.
High, fast-growing profits, competition among buyers, and trading in a sector that is in vogue, will all increase the multiple. Over-reliance on the current management team, key employees or a few key customers, and high anticipated expenses for the buyer (such as the need to raise pay at some stage because the workforce is earning below market rates), can reduce it.
Asset valuation is appropriate for stable, asset-rich businesses, for example, a successful property business, or a manufacturer with significant premises, plant and machinery. Asset valuations, however, can result in a conservative value, as they do not take into account future earnings.
The ‘net book value’ (assets less liabilities) in the accounts is refined (for example, property or other fixed assets may need to be revalued, old stock in the books at full value may in fact only be saleable at a discount; there may be debts to the business that are clearly not going to be paid) to arrive at the asset valuation.
This calculation, based on future cashflow, is appropriate for stable, mature, cash-generating businesses. For example, a publishing house with a large catalogue of titles.
Add up the dividends forecast for each of the next 15 years (at least), plus a residual value at the end of the period. Then calculate the current value of each future dividend using a ‘discount interest rate’, which takes account of the risk and the time value of money, to arrive at a discounted cashflow value.
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