To run a successful company, you need to know your finances inside and out. That extends to knowing the value of your business.

Determining your business valuation will give you a better sense of your prospects for shareholder growth and for a possible sale down the line. You can also use your valuation to help business owners, investors and other stakeholders understand your business’s worth and how it may develop.

What is a business valuation?

A business valuation is the sum of a company’s monetary value. It considers details like cash flow, operating assets and intangible assets. By taking the projected market value of equipment and subtracting set expenses, like payroll, rent and operational costs, you’ll get a strong idea of your company’s worth.

As long as you have an existing accounting system in place, you have access to the numbers you need for business valuation.

Why you should know the value of your business

Having an accurate idea of how to value a small business will allow you to make informed decisions and leverage each new success. Your valuation can come in handy if you’re thinking about selling your company, sharing equity with your employees or hoping to apply for the best business loans available. It can also help you make wise investments and track your growth goals.

How to value a small business

Three methods are commonly used for business valuation. Choosing the right one for your business may depend on your income, business model and plans. Take the time to:

1. Catalog intangible assets: Assign an estimated monetary worth to any nonphysical assets, like brand recognition, company reputation and patents.
2. Collect and organize existing financial documents: Having your cash flow statement and balance sheet on hand will help with your calculations.
3. Set goals for your business’s value and growth: Whether or not you’re planning to sell your business, setting a goal will help you track growth and establish expectations.

Completing these steps will reduce confusion and wasted time as you come up with an accurate valuation. Following your research, you should consider adjusting your business’s spending and resource allocation.

Three methods of valuing a business

Asset-based valuation

The adjusted book value (or adjusted net value) method is the simplest. To get a basic business valuation — sometimes called your book value — subtract your business’s liabilities from the total value of its assets. This will likely echo the value you see reflected on your balance sheets.

This method does not thoroughly examine intangible assets or additional expenses like rent and employee benefits. For this reason, the asset based approach is suited to smaller businesses with fewer operating expenses and a smaller team. It also often works well for businesses that hold investments or real estate because it emphasizes the value of both and for businesses that have been generating losses.

Market based valuation

This approach provides you with an estimated business value by comparing your business with similar businesses in the same industry. By calculating comparable assets, or “comps,” you can determine how you measure up against others. You can apply this method to find the worth of individual assets, like equipment, your real estate or your business as a whole.

You may also benefit from identifying your net debt as a part of the market approach. To do this, you can use a ratio that compares your company’s cash flow to its debt. You’ll want to adjust for unique risks or benefits that could impact the overall value of your company. High market share, positive reputation or unique patents will increase your valuation.

You'll want to make adjustments for unique risks or benefits your company may have that could impact its overall value. A high market share, positive reputation or unique patents will increase your valuation.

This approach has two key variations:

• Liquidation valuation: This method, usually used by companies considering closing, simply refers to the value of a company as if all its assets were liquidated and its liabilities paid outright. The resulting number is the company’s value.
• Going concern valuation: This is specifically used to value companies expected to continue operating. The going concern value encompasses intangible assets (such as intellectual property and customer base) that the liquidation value does not. It’s likely to result in a higher final value.

Income based valuation

The income approach is forward-facing. You determine the value of your business by looking at future income projections. The number you end up with can then be adjusted to meet known variables, like predicted periods of growth, changing tax rates or dips in the market.

There are a couple of different ways to determine income-based valuation:

• Discounted cash flow method: The discounted cash flow approach to business valuation calculates your cash flow over a period of time, often five years. This method relies on forecasting. So you’ll need to obtain or prepare a forecast of net cash flows for the chosen period, calculate your “terminal” or “residual” value, determine your appropriate discount rate and know your capitalization rate.
• Capitalization of earnings method: The capitalization of earnings method is another way to figure out the value of your business. The most important part of the capitalization of earnings approach is the assumption that your profits, finances and growth will be steady from year to year. You determine this steady earnings number, then discount it using an appropriate capitalization rate to find a present value.

Generally, the income-based approach is a good choice for companies with profitable operations, and either method can be well suited to a business seeking aid with growth. Your resulting value can indicate a need for increased marketing, expanded product lines or additional funding to meet your goals.

It all adds up

Ultimately, the best method to value your business depends on several factors, including size, projected growth and future goals. By tapping into all the resources available, you’ll be better able to choose the method that’s right for you and understand the numbers and figures that go into determining valuation.

Interested in learning more? Reach out to a Chase business banker to learn other ways you can manage your finances and what other resources are available.