What's Your Business Worth? Valuation is a Powerful Management Tool

Thomas Taylor - Sunday, October 16, 2016

Circumstances, along with the decisions you make every day in your business ultimately determine it's value.

And for most people, the exit value of their business is the main reason they take on the risk and hard work of running a business. In the early years owners often take out less in cash than they would earn as a salary working for a larger organisation.

However, most business owners don't tend to think about the value of their business very often - and they probably should. Changes in valuation over time is probably the best way to determine performance and progress.

I'm not talking here about expensive external valuations but rather using a simple calculation based on the present value of five years free cash flow and an industry rule of thumb as a terminal value. If that all sounds like Eskimo to you let me step you through it....
Net Present Value = a formula in excel... or read more about it here.

Free Cash Flow = how much cash you realistically forecast you can take out of the business each year for the next five years. Note that tax, working capital changes and capital expenditure are included in each number.

Industry rule of thumb = most industries have valuation rules of thumb. For example, for a lot of professional services it's 100% of fees. Because you are inserting this number in year five of your calculation the time value of money (discount rate) means that the accuracy of this number is not as critical as the calculation of cash flow in each of the years leading up to it.

You need then to determine a discount rate which is your cost of capital plus a margin for risk.
The final answer should be a good approximation of the businesses' value. It might not be exact because of a bunch of industry specific reasons, and you should always get specific advice if you are planning to buy or sell, but the key here is to use the valuation as a tool to measure changes in value. I think it should be done at least quarterly.

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