This archive report was first published on 10 January 2020.
Understanding Business Valuation ¶
Business valuation is a complex process that requires careful consideration of various factors. The value of a business is ultimately determined by what buyers are willing to pay for it.
Before valuing a business, it's essential to establish the prices paid for similar businesses in the recent past. This information can be obtained from accountants and business brokers.
Methods of Business Valuation ¶
There are several methods used to value a business, and no one method is more valid than another. Valuations are usually based on a combination of methods.
Net Worth Method ¶
The net worth method involves calculating the difference between a business's assets and liabilities. Assets minus liabilities equals net worth.
When calculating a business's net worth, it's essential to consider both tangible and intangible assets. Tangible assets include machinery and equipment, while intangible assets include goodwill and intellectual property.
Annual Net Profit Method ¶
The annual net profit method involves valuing a business based on its annual net profit. Many industries have a ratio for valuing a business in this way.
For example, a business in a particular industry with a net profit of 50,000 shillings might be valued at 3 times its annual net profit, which would be 150,000 shillings.
Valuing Assets ¶
A business's assets are a vital part of any valuation. Buyers and sellers need to establish exactly what assets will be sold in any transaction.
A business has three types of assets: current or short-term assets, non-current or fixed assets, and intangible assets.
Valuing Current Assets ¶
Current or short-term assets include accounts receivable, inventory, and other liquid assets. They're assets that can be reasonably expected to be converted into cash within 12 months.
Valuing Non-Current Assets ¶
Non-current or fixed assets are long-term or permanent business assets. Non-current assets include land, buildings, plant and machinery, tools, motor vehicles, and computer equipment.
Non-current assets are usually valued by deducting the accumulated depreciation from the original purchase cost.
Valuing Intangible Assets ¶
Intangible assets play a major role in valuing a business. They include things like patents, copyrights, goodwill, customer lists, and intellectual property.
Intangible assets can be difficult to value, and it's often necessary to seek professional assistance.
Fair Salary for Owner ¶
Owners who work in their business are entitled to a fair salary for their work. This is the concept of a fair salary for owner – the amount you'd pay someone else to do the hands-on work you'd do.
When valuing a business, it's essential to consider the fair salary for owner. This includes superannuation.
Fair Return on Net Tangible Assets ¶
A specific example of fair return on investment is fair return on net tangible assets. This is the return you'd expect from the net tangible assets of a business.
For example, a business with tangible assets of 200,000, liabilities of 80,000, and intangible assets (including goodwill) totalling 20,000 would have net tangible assets of 120,000.
The fair return on net tangible assets you'd expect to get from this business, assuming an expected ROI of 20%, would be 20% of 120,000, or 24,000.
Super Profit ¶
Super profit is the excess a business might return you after you've taken out fair salary for owner and fair return on net tangible assets. It's the amount you'd expect to receive from the business after deducting what you'd receive if you got a job in the business and invested the money you'd spend on the net tangible assets elsewhere.
