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- 3 How Do You Decide the Value of a Business to Buy?
- 4 Establish a Company Valuation
Buying a business can be a risky proposition; if you pay too much for a company, it might take several years before you recoup your investment, and in the worst case scenario, you might never make your money back. There are several methods for calculating the valuation of a company. The riskiness of the investment, how long you want to hold on to it as well as how it fits in with your other enterprises all must be considered.
Calculate the Value of the Assets
Add the replacement costs of the assets. Regardless of the business' revenues or profits, its assets can be sold. These assets include inventory, equipment and vehicles. One way to place a valuation on the company is to calculate the total value of the assets you will be gaining by purchasing the company.
Establish the Company's Revenue Stream
Establish the company's revenue stream. Revenue is the amount of sales, regardless of whether or not it is greater than the business' expenses. A valuation might be a multiple of the business revenue stream.
Valuation modeling in Excel may refer to several different types of analysis, including discounted cash flow (DCF) DCF Model Training Free Guide A DCF model is a specific type of financial model used to value a business. DCF stands for Discounted Cash Flow, so the model is simply a forecast of a company’s unlevered free cash flow discounted back to today’s value. ExitAdviser's business valuation approach gives you the confidence to defend your asking price in front of any prospective buyer. That's because it uses Discounted Cash Flow (DCF), the most widely respected method of valuing an ongoing and profitable business.
In an industry in which two times the revenue is an appropriate valuation, a company with annual revenues of $400,000 would have a valuation of $800,000; in an industry where three times revenue is appropriate, the valuation would be $1,200,000. A business broker can provide advice as to what is an appropriate multiple for a particular industry.
Analyze the Company's Earnings
Analyze the company's earnings. Earnings are the company's revenue minus its costs; it is the amount that a company clears during a reporting period. Valuation is based on what this amount is worth to the buyer.
Calculate the Net Present Value
Calculate the business' net present value. If you want a 20 percent return on your investment in a company with $50,000 in annual profit, deduct 20 percent for each year you have to wait to recoup your investment. For year one, divide $50,000 by 1.20 for a result of $41,666.67. For year two, divide $41,666.67 by 1.20 for a result of $34.722.23. Continue to deduct 20 percent each year for the number of years you're in the business, and add these values together.
In this example, an investment to be held for three years would have a net present value of $41,666.67 + $34,722.23 + $28,935.19 = $105,324.09. For a riskier investment, you might demand a 50 percent return; in this case the net present value would be $33,333.33 + $22,222.22 + $14,814.81 = $70,370.36.
Assess Non-Financial Factors
Assess non-financial factors. Regardless of the cash value of the business, its purchase might be of value to you. If you own a bookstore next to a coffee shop, you might wish to purchase the coffee shop to drive business to your bookstore. You can assess the value of such a business on its own merits or by what you would otherwise spend in marketing costs.
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About the Author
Catherine Lovering has written about business, tax, careers and pets since 2006. Lovering holds a B.A. (political science), LL.B. (law) and LL.L. (civil law).
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Investors who want to determine the possible returns of their funding, plus figure the impact of amortized goodwill and other factors, will certainly want to check out this preformatted Excel spreadsheet.
The Investment and Business Valuation tool is a preformatted spreadsheet with four tabs: Assumptions, Before (investment), After (assumptions regarding value of investment), and Results (Return on Investment). The initial tab, Assumptions, lets you choose either New or Existing investment and to enter a number of key factors: taxation and amortization, capital, and cost of capital--including risk-free rate, market risk premium, and weighted cost of capital. The interface is well-designed for leading the user step by step through entering assumptions regarding taxable and nontaxable revenue, operating expenses, investment expenses, existing assets, and capital expenditures for up to five years. The spreadsheet performed very well in our tests. Entering data--and knowing where to enter data--was a simple matter, although for the latter, some understanding of accounting principles is necessary. We were pleased with the built-in financial analysis charts and their ease of use. Also very handy were charts for Depreciation, Asset Disposal, Goodwill, Tax Calculation, and other elements important for determining potential ROI. For instance, the Annual Cash Flow trending chart and the Comparable Investment Score charts provide excellent data for helping to make important investing decisions.
The trial period is adequate for anyone familiar with investment procedures, and the price is nice. This is a pleasing little spreadsheet to add to your tool portfolio.