Rough estimates of business value should be evaluated as fast as possible if you have received an offer to purchase a company or are planning to attract an investor to develop your business.
And what assessment will be optimistic, pessimistic and real.
The main shortcuts for business evaluation are following: by asset value, comparative method and as a source of money.
- The net asset valuation method is advisable to use when the company ceases operations and, in principle, doesn’t plan to make a profit in the future. Otherwise, business owners will not agree that the company is worth as much as they give for used machines and premises. Business valuation hacks should be precise and done in a timely manner;
- The comparative method is also rarely applicable. Transactions for comparison are not published in newspapers. And the amounts in those that are published cause healthy laughter. You can use insider information, but in this case you cannot be absolutely sure of all the details, and therefore it is difficult to get everyone interested in the assessment to have equal confidence in such information.
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Business as a source of money
One of the most quick and easy methods for business valuation is considering a company just as a source of income. A simple formula for valuing a company using this method is: “Take your company’s EBITDA and multiply it by X.”
Let’s clarify what EBITDA is and what X is. EBITDA is earnings before taxes, bank interest and depreciation. To get it, you need to subtract the above three amounts from the profit. It is believed that in this way all details that are not directly related to the success or otherwise of the company’s operations are removed. All scheme payments. The use of EBITDA has its detractors, especially if the company incurs large costs of maintaining real estate and assets, but EBITDA is now more or less accepted by most appraisers as a relevant indicator.
X is the multiplier. A coefficient that shows what ratio of profit and price of a company in the country’s economy is considered correct. The second question is what X is and within what boundaries it can be located. Some say it’s 5, some say 7, some remember Europe and 13, and some even say that he has an American company and needs to be multiplied by 25.
It is important to understand that there are many banks, and they compete for our money. If one bank gives 10%, and another – 8%, then, other things being equal, the second will be left without depositors. In addition to the interest we receive for using our money, there is also risk. But, it is one of the fastest ways to estimate a company’s worth. For example, a bank from the top ten gives 10% per annum, and a small bank with one branch also gives 10%. To the question of where you will take your money, the answer will be obvious. What if the second bank offers not 10% per year, but 50%? Or 100%?
The same scenario works with business. The general rule is that the higher the risk, the greater the return must be to justify the risk. Approximate business valuation techniques include high-risk scenarios and methods, so consider them more precisely. As the more quick and easy method may be reviewed, the more risk factors it has, usually.
Recalling the previous example, if a bank gives 20% per annum, then 20% will not be enough for a business, because a bank deposit is usually less risky.
In addition, when comparing investment risks, you should not focus only on deposits. It is not bank deposits that are considered the least risky around the world, but government bonds. We have experienced several collapses of states and treat them without reverence, but all other options are even worse.
How to determine the market multiplier
Even the most simplified approaches to business valuation should include actual market multipliers. The most common market level of investment is the yield on the average annual deposit in a bank. Now it is approximately 13.5%. An investment in a business is usually riskier than a deposit in a large bank, so such an investment should have a higher return. You need to add about 5% – this is the standard additional risk fee in the world.
Therefore, the business must bring in at least 18.5%. This is an average, non-risky, well-documented income.
By understanding the average percentage of profitability in the market and knowing the profitability of a particular business, we can determine the value of such a business. For example, if a business brings in 18.5 million per year, understanding that the average profitability of a business is 18.5%, then the value of the business (Y) is 100 million.
In other words, our business, excluding problems and debts, could be worth around five of its annual profits. The maximum ceiling at which it can be valued is seven profits. But here the company is already beginning to declare that its reliability is higher than that of a bank. And in principle, nothing in Ukraine can cost more than 11 annual profits in foreign currency.
