How to value your business

How to value your business

How much is your business worth? This month we explore how to value your business.

The answer to how to value your business is not straightforward, the aim of this article is to help you to understand this process clearly. However, this article does not show all of the complexities of assessing a business’s worth.

The accurate way to value your business is not a % of turnover as this does not reflect the profitability or the individual nature of your business. More importantly it does not reflect the way potential buyers behave in assessing the value in your business. The only way to value a business with accuracy is using a multiplier of the adjusted net profit.

Example 1.

A company set up in 2020 selling discounted Apple products including iPads at a price unrivalled by other stores. Turnover in 2022 was £2,000,000 and the company made a profit of £50,000. Using the turnover method and using a widely used percentage of between 75% and 125% of turnover, gives us values between £1,500,000 and £2,500,000 for the company’s worth. This clearly over values the business as the actual net profit is low, any potential buyers are effectively buying turnover by discounting the product.

The best method to value any trading business is by using a multiplier of the adjusted net profit. For example, giving an alternative valuation of Net Profit £50,000 multiplier 5, value £250,000. Even with limited information available I think you would agree this is more reflective of the low margins of the business. There is an argument that once the business is established, they can start to increase margins, but that is in the future.

Example 2.

The same company used a slightly different business model and worked hard at maintaining high profit margins and a longer-term view on sales. This company’s turnover in 2022 was £1,200,000 but with a net profit of £200,000. Despite lower sales using the same multiplier on the net profit of £200,000 the value would be £1,000,000 reflecting the higher profitability of the business.

This is a very simplified example, real life is always more complicated, but it does illustrate that a valuation based on turnover is not accurate. The multiplier that is used on the adjusted net profit should reflect any potential future sales and the probability that they will become actual sales.

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Posted on by JS Reakes

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