The traditional method for valuing a business is the multiplier, a mathematical equation that ‘should’ give you a realistic figure on what the business you are hoping to purchase is worth. Here it is below for reference:
Net Profit of Business x Multiple of Sector = Valuation
However, this doesn’t take into account any variables, new opportunities or true earnings that the business could possibly achieve.
Sure, by using this method you might attempt to get yourself an acquisition at a bargain-basement price, but I find this to not offer a true reflection of the value and potential of a business.
Instead, you need to look at all of the variables and opportunities and threats that impact the business before coming up with a final figure.
To give you a helping hand when it comes to business valuations, here are a few calculation models and areas that are well worth a little extra consideration.
Adjusted Net Profit Calculation
Sometimes the real profits created by a business are obscured as audited accounts are not managed for bottom line presentation, and for this reason, it is important that you apply an ‘adjusted net profit’ calculation.
This calculation takes into consideration add-backs which are items and adjustments that are relevant only to the current management of the business and/or include exceptional and non-recurring items.
Add back items include things such as company cars, pensions and even health cover.
What’s the multiple?
In the first calculation mentioned in this blog, we talk about the multiple. Where so many individuals go wrong in valuing a business is getting the multiple value wrong and therefore end up with a financial value that doesn’t truly reflect the correct value of the company.
There are plenty of variables that should inform the multiple, including:
- Profit margins
- Company sector position
- Healthy/unhealthy financials
- Contracted income for forward earnings
Although this may seem complex, there is a range of rule of thumb formulas that you can use to inform your multiple. For example, multiples for SME non-listed companies can range from 1x ANP to 10x ANP, but be aware that is will give you an approximate value.
One final but important element to consider when valuing a company is the individual structure of any deal that’s being put together.
Most deals have cash as just one facet of the overall agreement, with assets or deferred earn-out mechanisms often making up a significant portion of the contract, so it is well worth looking at the deal as a whole, before attaching a monetary value as there is a strong possibility that there are other elements to the deal aside from the sole value of a business.