The value of a business is important for both buyers and sellers, ensuring fair trade before a merger or an acquisition. There are a lot of different ways to give concerned parties a fair valuation of the company. It might be based on the worth of all assets combined, the revenue it makes in an agreed-upon period of time, its financial condition and performance compared to similar companies, and even the projections for its cash flow.
One of the most common methods in company valuation is the times-revenue method. It determines the maximum possible value of a company based on its current revenues, multiplied by a certain factor depending on the industry. This sets a range of values, or a rough estimate, for the valuation of a business entity. If you’re looking to gauge a company, here’s a step-by-step guide on identifying the value of a business based on revenue.
1. Prepare The Required Information
Whether you’re buying or selling, preparation is an important step in business valuation. First, you need to understand the purpose of the valuation, which usually justifies the method used in computing for its value. More often than not, this assessment surprises the business owner or the potential buyer, especially after seeing an estimated value of the business.
It’s important to understand that more than the involved parties’ projections or expectations, business valuation exists to provide an objective measure of how much a business is worth. This is called the standard of value. Meanwhile, your presumptions or circumstances you find surrounding the deal is the premise of value, which explains the motivation behind the deals. It explains the creation of value expectations based on the presumption that the acquired business will continue as such, with its revenue upholding and assets generating value. Proper financial planning can help you manage your expectations, regardless of whether you’re buying or selling.
2. Adjust And Update Financial Statements
Usually, business valuation requires the service of professional appraisers. In the times-revenue method, the most important is the revenue over a specific timeframe. Usually, appraisers request the financial records that show your revenue for the previous fiscal year since it’s the most updated reference for your company revenue.
Additionally, it is during this stage that it’s made apparent to both parties how the business has been doing recently. It has an updated list of assets and liabilities and even provides an insight into the company’s efficiency and liquidity–two of the most important metrics to create informed decisions regarding the expectations of the valued company.
3. Complying With The Business Valuation Process
Now that the relevant documents are prepared, it’s time to proceed with the valuation process. Generally, revenue records are based on those recorded in the proforma financial statements. Then, it is multiplied by a factor that is determined by different factors including the general economic conditions and the industry where the business belongs to.
While the times-revenue method for business valuation based on revenue provides the “ceiling,” this process also determines the lower price limit for the business concerned or the “floor.” Both the floor and the ceiling are commonly used together in the valuation of small businesses. This completes the range of values that the buyer and seller can negotiate up. Additionally, the floor value of a business is often the liquidation value of the business assets, which constitutes the lowest possible price for the business in line with existing market standards.
Additionally, parties can request to recompute business value using other methods and compare the pros and cons. Despite the use of multiple computation methods, the objective remains the same: arrive at a value for the business that is fair and amenable to the parties involved.
4. Getting Into The Details And Negotiating
This is often the most painstaking process, having the seller and buyer engage in a detailed conversation about how much the business will be sold, if ever. Aside from the values provided by the business valuation method earlier, it gives both parties the opportunity to negotiate the deal in their favor. Perhaps there’s an undervalued asset that could be worth more in the future, backed by market data. Also, there might be an argument for the previous fiscal year being significantly lower than the previous years that the business has been in operation.
Aside from multiple valuation methods for cross-checking, you can also use business valuation software to help you cut down on manual computations and present the data you need in a more organized format. By automating the calculations, you eliminate human error and allow both parties to simulate multiple valuation scenarios.
5. Arriving At A Business Value Synthesis
After exhausting all methods, generating the range of possible prices, and cross-checking with other strategies and references, concerned parties can now decide together on what the business is actually worth. It is important to note that the times-revenue method is a general estimate based on the industry and economic conditions, and is usually used in conjunction with other, more specific methods.
If you’ve enlisted the help of an external business appraiser, you might be introduced to a weighting scheme to assign weights to different aspects of the business depending on their perceived importance. It helps bring arguments and discrepancies into the level ground, leading to resolution and agreement.
Conclusion
Business valuation is a cooperative effort that requires proper preparation and diligent effort. The use of the times-revenue method is an easy technique to provide an insight into how much your business might be worth in the context of its industry and the general economy. To make sure that the deal remains fair for everyone, remember to be transparent at all times. Not only will it lead to the best valuation for the business in question, but can also help create a promising business connection for the parties involved.