Your Business’s Value: The First Step to Sell Your Business
If you are considering selling your business now or in the future, your first step should be to get an idea of its value. The business’s value determines the health and well-being of your firm. It is more than just the economic value, which includes your economic profit or shareholder value. It also encompasses other forms of value, such as customer value, employee value, societal value, and more. If you know exactly where your business is at in this spectrum, you can sell your business at a better price.
Most small businesses owners often get caught up with their emotions. Sometimes, their feelings and personal thoughts about their business cloud their financial judgement. What entrepreneurs need to practise is seeing their business as just another investment they can gain a profit from.
How to Know a Business Value Based on Profitability Ratio
Your business’s profitability ratio is your return on capital. It measures the return that a specific investment (in this case, your business) generates for capital contributors (or your bondholders and stockholders). In simple terms, your return on capital relates to how effective your company is at turning an investment into actual profits.
To determine your business’s value based on this information, you need to use what is called the Capital Asset Pricing Model (CAPM).
You can start the assessment using a risk-free rate. This rate represents the interest that an investor should expect from investing in your business, free from any risk over a specified period.
Here is how to determine your business’s risk-free rate using the CAPM:
Set a timeline for your assessment first. You can use the current 10-year government bond rate for a risk-free rate of 3.5 per cent. If you think that your business is riskier than that, aim for a rate of return exceeding 3.5 per cent.
Then, choose a figure that you think is an appropriate benchmark for your business.
The formula to use is ERi = Rf + βi (ERm − Rf), wherein ERi is your expected return of investment, Rf is your risk-free rate, βi is your beta of the investment, and (ERm − Rf) is your market risk premium.
Let us say that you were to invest in a broad portfolio of publicly-traded blue-chip stocks. Assuming a risk-free rate of 3.5 per cent with an average portfolio return of 7 per cent, you can expect a return between 6 to 8 per cent above the risk-free rate of about 10 to 10.5 per cent.
On Risk Assessment
Investors often purchase a business depending on the risk or how likely it is that your business can produce the same level of revenue and profit in the coming years. When assessing risk level, here are the factors that come into play:
The associated risk based on industry type
The dependency of the business on the business owner
The dependence of the business on a small number of major clients
Why This Is a Better Way to Measure Your Business Value
If you ask business owners of their business’s value, they will often refer to the profit they make based on their current sales. However, that is only one part of the equation, as it does not give you the whole picture of the business’s situation.
Remember that every business is somehow the same and made up of the following pot of money:
Equity Funding - The money you invested.
Debt Funding - The money you borrowed from the bank, lease equipment, bank overdraft, and more.
It also includes other sources of money you use for the business. For example, you could have provided customers with credit terms, or you may have invested in stocks. All these serve as your business’s pot of money. When measuring your business’s value, it should be your profit against the pot of money you have, not purely based on the sales you generate.
Going through this assessment gives you a clearer understanding of where your business currently stands. If you want to make the most out of selling your business, you need to put it in a better position through constant improvement. Also, try to address all the potential risks in your business that might deter prospective buyers. That way, you raise its value even more.
If you need further clarification, let an accountant in Gold Coast help you find the accurate value for your business. New Wave Accounting is not just an accounting and bookkeeping service provider in Australia; we also help entrepreneurs understand, grow, and scale their businesses. Contact us today to help reach your goals faster.