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How to evaluate the value of a business

By Edited Apr 13, 2014 1 0

When taking over a company, evaluating it is a crucial step before the conclusion of the sale. There are several methods to estimate the value of a company, which must be combined to find the right price that will satisfy both the buyer and the seller.

Elements to be evaluated

The acquisition of a business may include:

  • Individual assets, the purchase of a trademark, a building.
  • Goodwill and consumer's trust.
  • Shares of Limited Company Limited Liability (LLC).
  • Shares of other share holders.
  • Stock of products (if a product based company).

Before embarking on the assessment of a company, the buyer and the seller must agree on the terms of the purchase: Refund or not current accounts of partners, purification potential liabilities, balance sheet, commitments given to the customer, employment contracts, outstanding loans, leases ...

Questions to ask upstream

Before leaving the calculator, it is necessary to consider some important points:

  • Who is the share leader in the success of the enterprise.
  • What is the present situation of the company: Is stable, increasing, in decline?
  • What is the impact of leadership on the charges of the company: how to remunerate the transferor, how he pays his associates etc.
  • What is the nature of the relationship of the transferor with its suppliers: they give access to purchase conditions likely to be challenged?

The answers to these questions must be taken into account by the buyer to play down or, more rarely, to increase the selling price.

Different valuation methods

There is no one but several methods for evaluating companies. Each brings a vision of the company, more or less relevant depending on its characteristics (size, financial condition, prospects, ...). Generally, it is necessary to combine different methods to obtain a multi-faceted vision of the company.

  • The asset method applies to midsize businesses, rather stable. It consists in evaluating the assets of the company (it has), then subtract the value of its debts, thereby obtaining the net assets.

This method gives a fixed value of the company, which does not take into account its situation (loss or growth), its economic potential or profitability. It merely provides a replacement value or liquidation of the company. 

  • The comparative method is suitable for times of shops and craft activities. It consists in comparing the company with others, with a similar profile and whose transaction value is known. Specifically, this method is to calculate the theoretical value of an enterprise of a scale or a ratio (commonly applied to sales) observed in the same industry and in the same geographical area.

Easy to implement, this method gives wide ranges which need to be refined. 

  • The method of profitability can be applied to all companies. It estimates the value of the company under its future ability to generate profits. In fact, this method is to assess the expected profitability of the company based on the results observed in the past. Several formulas are then used: those based upon the gross operating surplus, others on the profit before tax or cash flow of the company.

Economically justified, the method returns may be subject to discussions between the transferee and the transferor (the choice of formula, assumptions of future profits ...). It also requires good master the principles and rules of financial analysis.

Namely : valuing a business is not an easy task. Unless you are an experienced financial analyst, the buyer may be assisted by:

  • Many organizations and foundations support the creation and takeover of companies.
  • A corporate lawyer, notary or accountant.

Buyer and seller have different motivations. The buyer seeks to pay the "fair price", while the seller tries to maximize the value his company. The superposition of assessment methods is the appropriate way to begin trading on the sale price.


 

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Jul 11, 2012 2:19am
ajaykumar04
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