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Business Advice

How To Value Your Small Business?

Valuation Methods for Small Businesses in Australia.

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Whether you are planning to sell your business, attract investors, or want to gauge your financial standing, understanding the value of your business is essential.

Valuing a business and understanding what your company is worth in the market is a crucial step in the journey for any owner. 

To determine the worth of your business, it’s essential to familiarise yourself with different valuation methods. In Australia, small business owners can value their business in several ways. However, seeking help from experienced valuation specialists ensures you have all your ducks in a row.

This blog will explore four standard valuation methods for small businesses, including their benefits, and guide when to use each technique.

Valuation Methods for Small Businesses in Australia

Valuation methods provide a systematic approach to determining the value of a business. Here are four standard methods used to value small businesses in Australia:

1. Asset-Based Valuation:

The asset-based valuation method calculates a business’s value by summing up its assets (property, equipment, inventory, and cash) and subtracting all liabilities (loans or debts) to find the net asset value.

This method is one of the simplest forms of valuation. It suits businesses that rely significantly on tangible assets, such as manufacturing or retail. It is instrumental when you want to understand the liquidation value or the value of physical assets.

The main benefits of this method are:

  1. Tangible assessment: Asset-based valuation provides a concrete understanding of your business’s worth by considering its physical assets.
  2. Useful for specific industries: Businesses in manufacturing, retail, or property sectors often rely on this method due to their asset-heavy nature.

Example: If you own a small construction company, you would consider the value of your machinery, vehicles, and other equipment when conducting an asset-based valuation.

2. Market-Based Valuation:

The market-based valuation method determines the value of a business by comparing it to similar companies that have recently been sold. 

This method relies on market data and can provide a realistic valuation based on actual transactions. Due to the complexity of variations in the market, this method may be the most accurate, but the monetary value changes according to the economy. It is most beneficial when a reasonable number of comparable businesses with recent sales data and the market is active.

The main benefits of this method are:

  1. Real-world data: Market-based valuation relies on actual transactions, giving you a tangible reference point for your business’s value.
  2. Reflects market conditions: This method provides an up-to-date valuation by considering current market conditions and industry trends.

Example: If you own a small cafe in Melbourne, you can research and analyse recent sales of similar restaurants in the area. Based on their selling prices and financial performance, you can estimate the value of your cafe.

3. Earnings-Based Valuation:

The earnings-based valuation method assesses the value of a business based on its earning potential. This method is beneficial for companies with stable and predictable cash flow or when you want to highlight your business’s income-generating capacity.

You can do this by calculating the average annual earnings of your business over a specific period. Then, select an appropriate capitalisation rate that reflects the risk associated with your company and industry. Divide the average earnings by the capitalisation rate to estimate the value.

Deciding the capitalisation rate for a business involves significant research and knowledge of the type of business and industry. The more volatile your sector, the lower the expected ROI from investors.

The main benefits of this method are:

  1. Future-oriented: This method considers your business’s expected earnings, making it suitable for companies with solid growth potential.
  2. Income-focused: Investors and buyers often use earnings-based valuation to assess the potential return on investment.

Example: Suppose you run a digital marketing agency with stable annual earnings of $200,000. Based on the industry’s average capitalisation rate of 10%, the estimated value of your business would be $2,000,000.

4. Discounted Cash Flow (DCF) Valuation:

The discounted cash flow (DCF) valuation method estimates the present value of a business’s expected future cash flows. It is often used for companies with potential for significant growth, and you want to capture long-term value.

This method determines the value of an investment based on how much money that investment will generate in the future. If the DCF is higher than the current investment cost, the opportunity could result in positive returns and be worthwhile for the investor. Of course, as this method relies on projections and estimations, it may need to be revised. 

The main benefits of this method are:

  1. Future-focused: DCF valuation considers the long-term potential of your business and the value it can generate over time.
  2. Flexibility: This method allows for sensitivity analysis by adjusting key assumptions to understand how they impact the value.

Example: If you own a technology startup with projected cash flows of $500,000 per year for the next ten years, discounted at a 12% rate, the DCF valuation will help estimate the present value of those future cash flows.

Know What Your Business Is Worth

Valuing a small business in Australia is a complex task that requires careful consideration of various factors. 

By understanding the different valuation methods available and how to conduct them, business owners can gain insights into the worth of their company in the market. 

Each method has benefits and is suitable for different scenarios, depending on your industry, financial performance, and growth potential.

Remember that business valuation is not an exact science, and different methods may yield different results. By using a combination of valuation methods and considering the specific circumstances of your business, you can make informed decisions and navigate the financial landscape more effectively.

Please consult with one of our business valuation specialists to ensure accurate and reliable valuations for your business.

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