Deciding the valuation of a small business is very important for owners. This is because there are multiple advantages of doing so. Firstly, it helps the person in becoming aware of whether he is getting the expected financial returns from the business he is engaged in. Secondly, it is essential to value a small business being put up for sale, to pay for it or get the right price. Even students of accounting and finance can hone their skills by learning to value a small business. Here is an overview of the most important factors.
1. Look at the Profitability
The best way to gauge the profitability of a business is to calculate the percentage of net profits earned by it over the total turnover in a particular period. The profitability can be calculated by taking a ratio of the net profit and the total income. Remember that net profit is calculated after deducting all expenses, taxes, depreciation and losses from the total turnover. The profitability calculation will help you in valuing your business and determining how sound it is.
2. Growth in Profits and Sales
You need to find out how much growth in profits and revenues has been registered over the years. If the trend is positive, then the business can be sold off at a premium to the current valuation, whereas if it is negative, then the overall business valuation will automatically go down.
3. Find Out the Liquidation Value
Another way of valuing a business is to find out the liquidation value. This means we need to calculate how much money will be generated by the sale of various assets owned by the company after paying off any debts and liabilities on the business. This method of business valuation is used in all parts of the world.
4. Comparison with Other Firms
Comparing the situation of the business with competitor firms is another way to value a business. You can find out how much valuation the competitor firm is getting for the sale and net profit generated by them and accordingly decide how much you should get for your business, by looking at your financial performance.
5. Strength of the Balance Sheet
The balance sheet is a financial statement prepared by taking assets and liabilities of a firm in the whole financial year into consideration. So, what you need to look at is whether the company has assets of high present value and whether it has sufficient cash in the books of accounts. A high debt component leads to high interest payments and reduced net profit margins. Valuation will be more if the debt is less or nil.
Looking at the return on investment and asset value is also essential to value a business. By taking these important things into consideration, you will be able to know the financial status of your business correctly.