Valuing a business consists of quantifying the value of a range of factors and weighing their comparative importance, which depends on the model of valuation employed – in turn chosen according to the sector, because different factors matter to varying extents depending on the industry.
The most common valuation method if you want to sell a business is a multiple of earnings – a ratio, determined according to the sector, of the income generated by the business. Income, or profit, is a tangible factor, meaning its value can be measured easily because you have a specific figure to work with. Creative accounting notwithstanding, there’s little argument about the true value of an annual £100,000 profit – it’s worth, well, £100,000 a year.
Other tangible factors are valued according to the unerring accuracy of the market – where demand meets supply. Unlike profit, they are invariably physical things and their value is simply derived by what people tend to pay for them; the market rate in other words.
Examples of tangible factors:
- Balance sheet figures – profit, revenue and cash flow
- Fixtures and fittings
Intangible factors, as you may have guessed, are invariably non-physical things whose value is difficult to determine. Subjectively determined, they could be ascribed wildly divergent values by a selection of different people involved in selling a business.
Intangible factors can include:
- Reputation and goodwill – ie, your reputation among customers and potential customers
- Relationships with suppliers
- The value of licences
- Any intellectual property patents
- Quality of staff
- Level and quality of competition and barriers to market entry for potential new competitors
- Amount of repeat business
- Threats – eg, forthcoming regulatory changes – or opportunities – eg, a boost in government funding for teaching English to immigrants will benefit a language school