Determining the value of a business
| Date Added: December 31, 2007 03:05:45 PM |
| Author: |
| Category: Business & Economy: Finance and Investment |
There are five things that should be taken into account when determining the value of a business. Those five things are performance in the future, the amount of financial leverage it has, what the expectations are for financial return, instead of profits; cash flow, and the structure of deals. We’ll look at each of these things in turn.
1. Performance in the Future While most people look at the past history of a business, the thing that really helps to determine value of a business is what the business will do in the future. The history of a company is helpful and shouldn’t be discounted, but not every business owner does things the same way. Therefore, the past performance is a guideline but is by no means completely accurate and infallible when it comes to determining what will happen in the future.
2. The Amount of Financial Leverage
If a business has high leverage, it generally means that it has a high base, which also means that the cost of capital is lower, and that will raise the value of a business. However, if the business has low leverage, and a low base, meaning the cost of capital is higher, that will bring down the value of the business.
3. Expectations for Financial Return
If a buyer has a high expectation on their investment return, that is going to affect the value of the business. Some of the factors that increase the buyer’s expected return on investment are a fluctuating sales history, uncontrollable or unpredictability in profit margins, concentration of customers, lack of management, and many other factors.
4. Not profits but cash flow
If a business has a high base for its fixed assets, and is concentrating greatly on working capital, chances are a lot of the company profits will be put back into the business. This lowers the value of the business, because the available cash for debt service is reduced. But the opposite is also true - if less of the cash that the company is bringing in is going back into the business, then that raises the value of the business.
5. Structure of the deal
There are three parts deals that come into play when determining the value of a business. First of all is whether or not the seller of the business offers financing to the buyer. In a recent study, it was determined that when financing was offered by the buyer to the seller the value of the business was increased. An owner can also increase the value of a business by having an asset sale instead of a stock sale.
One thing to remember when determining the value of a business is to take a look at the businesses in the area and do the research. Take a look and see what similar items are going for and determine how much money is going out each month. If you have questions about a business you are thinking of purchasing, there are plenty of financial experts that will be glad to help you with some advice and help in determining how much your business is worth and whether it is a sound investment. |
