Jun 03, 2014
The question we hear often from business owners is, “What is my business worth?” The easy answer can be a multiple of revenue or earnings (typically Earnings before Interest, Taxes, Depreciation and Amortization or EBITDA). It can be calculated quickly and is easy to explain. However, it may not tell the whole story. A professional business valuation will look deeper into the numbers and provide a more thorough analysis of the factors that drive value. If you really want to know what the business is worth, a business valuation will typically include a detailed analysis of the following factors:
1. Growth– Are revenues growing, flat or declining? More importantly, what is the expected growth rate in the future? Often times a valuation multiple may not fully recognize the value of growth.
2. Profit Margins- What is the trend for the gross profit and net income margins? A company that can grow revenue and maintain its margins will be worth more than a company that has revenue growth, but declining margins. A valuation multiple will not distinguish between a company with improving profit margins compared to a company with low or declining margins.
3. Cash Flows- Cash flows are the most important economic benefit of ownership of a business. Therefore, a business valuation will focus on cash flows, not revenue or EBITDA.
4. Cost of Capital- How risky is the business? A company with low risk will have a lower the cost of capital, which means a higher value. A professional business valuation will spend a significant amount of time analyzing the risk in order to estimate the cost of capital for the business.
5. Market Size- What is the size of the market and is there opportunity to capture additional market share? Is the company a small player or a market leader?
6. Management Team- Does the company rely on any individual? Can that individual leave the business without a disruption? A company with management depth will be worth more than a Company that has goodwill tied to the business owner or key person risk. A valuation multiple may not recognize the value of a strong management team and low reliance on any individual.
7. Capital Requirements - A valuation multiple may not reflect the difference between a company with a high fixed asset requirement compared to a company with little or no need for fixed assets. All factors being equal, a company that needs to reinvest in new equipment will have a lower value than a company with new equipment or few fixed asset requirements.
8. Financial Reporting- Are the financial statements accurate and reliable? If a company is paying for the personal expenses of the business owner, can those expenses be documented and added back? A quick valuation multiple of EBITDA may not include the recasting adjustments necessary to reflect the normal earnings of the business.
9. Customers– Does the company have a loyal customer base or are sales non-recurring? There is value in customer relationships that may not be reflected in a valuation multiple.
10. Employees- An experienced workforce in place may be one of the most valuable assets that is not on the balance sheet of the business. A valuation multiple of revenue or EBITDA may not reflect the value of this asset.
Although a valuation multiple of revenue or earnings may have some use in establishing a broad range of an expected selling prices for a business, the multiple has its limitations. There are no short-cuts to an accurate appraisal of the value of a business. If you want to know what the business is really worth, a professional business valuation will analyze and document the drivers of value and arrive at a conclusion that can used to fully understand and maximize the value of the business. O’Keeffe & O’Malley, Inc. can provide you with different levels of valuation services from calculations of value to full appraisal reports that can help you meet your objectives