Updated: Aug 8, 2019
The most common question we get asked from our clients is for us to assess the value of their business.
Business Valuation can be confusing as there are a large variety of techniques and approaches used to value a business. Largely, the process and end result can come down to a matter of expertise and experience on the part of the valuer, and can ultimately depend upon which valuation methodology the valuer uses.
The most commonly used approaches are
1) The Market Data Approach
2) The Asset approach
3) Future Maintainable Earnings approach
The Market Data Approach
This approach relies on a valuer using evidence based data from historical sales of similar business types.
Each industry, and each business type has a multiple of historical earnings ratio upon which a valuation can be performed. Multiples are varies for each business type. For example a Pharmacy will have a very different earnings multiple to a cafe or a car wash, and so on. Generally, accountants and advisers like this method of valuation as it does utilise market data and can give an accurate assessment of value in a particular sector.
The downside of this methodology is that it largely relies on historical data. When a new owner takes over there are no guarantees that the business will perform in the same manner as it did in the past. The second problem is that the multiple of earnings ratios change daily for each industry dependant upon a number of factors including new technology, buyer demand, negative growth, and changing consumer appetites. The data can also be difficult to find as business sales multiples earnings to sale ratio evidence is not regularly logged by any government body.
The Asset Approach
This approach is commonly used in sectors which are heavily invested in assets but which may not have earnings to match. For example, a Transport Company with a large fleet of Vehicles may have huge assets but may or may not be making huge profits. In this scenario, a valuer may assess the value of the business to be the value of the business assets minus the liabilities (loans) against those assets.
Future Maintainable Earnings Approach
This valuation methodology typically is used in industries which have a predictable and regular future income which is not reliant on the current owner. Gymnasiums, Property Management Companies, Management Rights, and many service based businesses which charge regular monthly or annual fees can be valued using this methodology. This method relies on market research and analysis and future projections.
So which method is best?
At the end of the day each of the above methods has its merits and can be rightly used in the valuation process. This being said, the true value of a business at any time is the amount a buyer is prepared to pay to a seller. Each buyer will have a different opinion based on their own unique set of circumstances and history. Despite and valuation that may be performed a buyer will ultimately decide a businesses worth.
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