How is a business valued? Calculating the value of an SME business

How is a business valued? Calculating the value of an SME business

Why do you need to know the value of your business? As a pioneering business looking to stay ahead, calculating your business’ value can be incredibly useful when it comes to raising funds from investors, selling your company or merging your business with another. So it’s important to measure your business value accurately as you don’t want to sell yourselves short or put off potential investors or buyers by overestimating your business’ value.

Valuation of businesses is an important part of the decision-making process for any investor. When looking to invest in a small or medium-sized enterprise (SME), there are a range of valuation methods that can be used to determine the value of the business.

How is a business valued

In the below article, we will cover all the different aspects of how a business is valued. Take a look at which methods are available to use when you are trying to gauge the value of your company:

  1. Venture Capital Method
  2. Scorecard Method
  3. Checklist Method
  4. Discounted Cash Flow Method
  5. EBITDA Multiple Method

This table summarise which valuation methods tend to be used at different stages of a business’ life cycle, although this is not definitive. There is no ‘hard and fast’ rule as to which methods can be used, however to help you on your journey, below we have summarised which methods can be used.

Value of a business

Venture Capital Method

This is a method of valuing a business based on the amount of capital the venture capitalists are willing to invest in it.

It takes into account the current market value of the business, its potential to generate returns for the investors and the risk profile.

It is often used in a combination with other valuation methods to set a fair market value for the business.

This method is more appropriate for businesses that have yet to generate profits, as it takes into account the potential future value of the business.

The venture capital method can be used to help determine the amount of capital needed to fund a business’s growth.

Valuing a business via the Scorecard Method 

This values a business by comparing it to similar businesses in the same industry, like a benchmark. Businesses of a similar size and in a similar sector can give you a good indication of the current value of your business. A value is assigned based on a comparison.

When valuation reports are created, to support the valuation method and value, you often use case studies of recent deals as empirical evidence to substantiate the value.

The scorecard method takes into account a range of factors, including financial performance, market share, customer base, and the competitive environment.

This method is useful for businesses that are not yet profitable, as it can help to show where the business could get to.

Checklist Method 

This method values a business by assessing the business’s financial performance, market position, and competitive environment. 

 The checklist method takes into account the current market value of the business, potential future value, and risks associated with investing in the business. 

 It tends to focus on the quality of the idea and the team that is going to develop the business, whether or not there are solid strategic relationships in place, and what kind of testing the product has gone through.

Because of this, it is often a valuation method for startup businesses and early stage investment rounds.

Discounted Cash Flow (DCF) Method

This is a method of valuing a business based on the present value of its future cash flows. The general concept is that a £1 today is different to £1 in the future (inflation etc) so a ‘discount’ is applied to the cash that the business expects to generate.

The discounted cashflow method takes into account the expected future cash flows of the business, and discounts them at an appropriate rate to calculate the business’s present value.

This method is useful for businesses that are already generating profits as there is a baseline to work from and model.

It does require some fairly detailed financial modelling, so it is not as simple as other methods, but it would also be considered a more robust model, which is more useful for the decision-making of investors.

You would need to be able to accurately forecast the profitability and cash flows of the business to be able to use this method – some groundwork to do first!

Business valuation via the EBITDA Multiple Method 

This is a method of valuing a business based on its earnings before interest, taxes, depreciation, and amortisation (EBITDA).

The EBITDA multiple method takes into account the current market value of the business and the earnings potential of the business in the future.

Businesses that are expecting to grow in the near future will find the EBITDA business valuation method useful as it factors in the growth of the business. This is what investors are particularly interested in. What has happened in the business to date is useful and performance might be strong, but they are buying into where it is going.

This is more appropriate for profit generating businesses, which are expected to continue on the same trajectory in the future. It takes the EBITDA of a business, often weighted over the last few years of trade and recent forecasts and applies an industry multiple to generate a value of the business.

Why not use our quick business value calculator tool?

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Written by Brent Morrison, Director. 

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