Business value is far more than dollars and cents. The government has one way of evaluating a business at tax time, but potential buyers, customers, and the competition are sizing up your business constantly – and they aren’t just interested in the bottom line.
Fair Market Value
Business valuation is made up of a fair amount of accounting and a lot of guess work. The fair market value of a business is what is used when a business is sold or for any number of other legal purposes. To determine the fair market value of a business, you must consider cash flow, tangible assets, appreciation and more.
The government calls a fair market value the dollar amount of a business where the seller and the buyer both agree. With such a loose definition, there are countless ways to estimate your business’s value. Depending on industry, your business value may be a product of a period’s cash flow multiplied by a certain number or something considerably more complex. There is no exact formula for determining the overall value of a company as values fluctuate within industries and over time.
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At tax time, your company is evaluated based on its debits and credits. Gross receivables and assets are offset by liabilities and expenses. At the end of the accounting process you have a company income that is tax worthy. This number is often far less than any true value of your company. Accounting and tax write offs help many companies find ways to make tax values far less than reported earnings. However, reported income through the government can help gauge your company’s progress and provide a starting point for evaluation.
Regardless of how much your company made in the last six months, the next six months and ever month after that matters much more to you, your competition and any potential buyer. If your company is growing rapidly with increased income opportunities, it will be valued more highly than a company that has seen its peak and is struggling to survive. If your company is at the top of its market segment, it will have different valuation than a new arrival just getting its proverbial feet wet.
A final consideration in your valuation formula is your company’s reputation within the industry and with your customer base. It is virtually impossible to put a dollar amount on reputation, but a reputation can certainly translate into increased or lost income. A great reputation for quality and service can win customers time and time again. A company with a reputation for shoddy service or poor products will have a hard time overcoming the stigma – even if the original rationale behind the reputation is no longer true.
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Your Valuation Formula
Every company will have a different valuation formula depending on your needs and your unique company. The best way to get an exact dollar valuation would be to hire a professional consultant experienced in your industry, but for a looser estimate consider the following formula.
1:- Find the net worth of your company today. Remove any clever accounting tricks such as officer bonuses to see your true cash situation. Your tax returns may be a good place to start to get this number. Some companies and industries prefer to use cash flow rather than net worth. The choice is yours based on your needs.
2:- Multiply your net worth by a factor correlating to future growth. If your company has grown steadily, you will have a high positive factor possibly even approaching nine or ten. Businesses that simply maintain or grow slowly will have a more moderate factor, and businesses in trouble may need to consider a factor of 1 or 2.
3:- Consider the number you got and think hard about your reputation. If you are the top player in an industry, you can probably greatly increase your valuation to reflect this. If you are new to the field without much reputation established your calculation should probably not change much. If you are working to overcome a hard time, you may have to lower your number to attract potential buyers.
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