How to Value a Business: Understanding the Underlying Numbers

Deciding the value of a company is necessary at many stages of a business’ lifecycle: in order to bring in investments or to sell a company, it’s necessary to decide just what value the business already has. Because business owners can get emotional about the organizations they’ve worked long and hard to create, as well as put different values on the various assets that make up a business, there’s a standard approach to placing a value on a company. While you don’t necessarily need to learn all the nuances of setting a company’s value for yourself, you do need to learn the practical aspects and how to understand how prices are set if you’re in business.

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Taking Everything Into Account

It might seem like comparing the money each business has in the bank is an easy way to set its value, but that method is like comparing apples and oranges: one company might be flush in a given month because it’s a seasonal business, while another may maintain low cash reserves because it’s bought expensive equipment (which it could sell to raise cash). Instead, it’s necessary to look at all the accounting behind a given business, including both past numbers and what you project for the future, so that you can accurately compare a company to others in the industry.

What ends up determining your company’s values are what assets your company currently owns (from equipment to intellectual property), what your company currently owes to other organizations (including obligations like loans and unpaid invoices), and what money is owed to your company (like your accounts receivable). There are other factors you can and should add in. Your customer relationships, for instance, are valuable, even if you don’t have a signed contract in hand. Calculating the value of each relationship is a matter of looking at how far into your sales pipeline a prospect is and what the likelihood a deal will actually close is. You can also put a price tag on your employee relationships: how much a principal employee is worth depends on the industry, but you can start by figuring out how much it would cost you to replace your staff.

All this information is the reason that many companies turn to a professional to set their values, especially for situations in which a lot of money will be changing hands, like a sale. It’s easy to miss a small detail that can have a big impact on the bottom line of just what your business is worth. You should expect that someone who’s considering getting involved with your company, perhaps as a buyer, might have a valuation of his or her own completed.

Understanding the Differences Between Companies

Not all types of businesses are the same. Setting the value of a startup comes with its own twists, especially when a startup founder is looking for investors. Many startups begin as little more than an idea, which doesn’t have a lot of value without execution. At the same time, startup founders need to convince investors to give them the money necessary to build something bigger — which makes it necessary to convince those investors that the idea is work something, even on its own.

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However, if you have a good grasp of the underlying basics of both business valuation and the strategies that make a business worth money, you can tackle the oddities of valuing different kinds of companies without too many problems. It’s just like any other question in valuation: it can be answered by gathering more data and setting the price for each component of the company.