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Businesses need to be valued for a number of reasons such as:
- Obtaining a listing
- Inheritance tax
- Capital gains tax computations
There are three main approaches to valuing a business:
- Asset-based - Value the assets of your business (buildings, machines, products, raw materials and any intangibles like brand if possible), sum it up and here comes the value of your business. In most cases this is not a valuation method appropriate for small companies.
- Cash flow based - Forecast future expected revenues and costs, arrive at an expected net profit, run the forecast for a period of time (usually five years), then calculate the terminal value (future cash flows), and apply a discount rate which reflects the time value of money and riskiness of your business to bring the cash flow to its present value. It is theoretically the best way of valuing any company, but also the most complicated and prone to mistakes.
- An analysis of comparable companies - Find a business which is similar to yours and has recently been sold, then obtain the actual value of the transaction.
For a small business you might apply a 'rule of thumb' model. To do this, first, you reassess last year’s accounts to calculate the actual net profit, then multiply it by a business category related multiple (service, retail, manufacturing). Small service related businesses are generally valued at a multiple of somewhere 2 to 2.5 times the annual adjusted net cash flow, while small manufacturing businesses generally receive higher multiples, 3 to 3.5 times range.