How Does The Weighted Average Method Affect The Income Statement How to Value a Business – The Free Business Valuation Calculator

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How to Value a Business – The Free Business Valuation Calculator

Every business owner should have a good idea of ​​the current value of their business even if they are not planning to sell the business anytime soon. But you may also need to know what the business value is in the following non-exhaustive list of scenarios. How many reasons do you need to find out what the company is worth?

  • Acquisition of a company or an external or internal division
  • Sell ​​companies or divisions externally or internally
  • Shareholder/partner and buy/sell agreements
  • Estate and Retirement Planning
  • Family law – separation and marriage
  • Drafting of commercial insurance policies
  • Drafting of personal insurance policies
  • The owner’s actual death or disability
  • The trial as plaintiff or defendant

The problem is that business valuation is a mixture of science and art that is more confused by the ‘list price’ presented by business owners and their often meaningless practices that have no business sense. The process of valuing a business is straightforward but needs to be followed carefully.

The assessment method

The cost of transferring any business (or any property for that matter) will almost always come down to the price agreed upon between a knowledgeable, willing, but not nervous seller and a knowledgeable, willing, but not nervous buyer. The purpose of the appraisal is therefore to indicate to the seller and/or the buyer the price that would be a good financial result for them based on the required rate of return. The purest valuation method is the discounted cash flow (or present value) method, but this method requires accurate knowledge of the company’s current and future cash inflows and outflows. Although this method is good for certain financial assets with guaranteed cash flow, it cannot be applied to companies with variable cashflow.

The next best option used by most business owners is a modification of the above method called the capitalization of future maintainable earnings method. This method requires the appraiser to estimate the potential annual income (earnings before interest and taxes) that will be used as the recurring annual amount in the calculation. The appraiser then applies the capitalization rate to those earnings at the required rate of return to value the company.

Future savings (profit)

Earnings are usually calculated based on the company’s past performance as well as estimated forecasts. Profit from the financial statements is adjusted to take into account various factors that are artificial or non-trading amounts in the financial statements.

Earnings before interest and taxes (EBIT) for each historical and projected year are weighted by certain assumptions to develop a weighted average EBIT or future retained earnings, which is considered the amount can be repeated annually based on the methods and assumptions used.

capitalization rate

The capitalization rate is the opposite of the required rate of return on a business investment. The higher the required rate of return, the lower the capitalization rate and therefore the lower the value of the business. Conversely, if there is no risk in investing in a company, the required rate of return may be 5% and the company is valued at 20 times the amount that can be afforded in the future. from. There are almost no natural hazards associated with running a business. More likely, the required rate of return is between 15% and 100% with a corresponding investment ratio between 7 times and 1 time. The more risk, the more return the investor needs compared to the investment costs to make the investment.

Since future cash flows have been calculated, the only way to change the company’s value is to change the required rate of return. The higher the required rate of return, the less the company is worth at the same level of future cash flows.

In the free business valuation calculator that I created on my website, there are only 7 factors that affect the required rate of return. Keep in mind that this is an oversimplified example because in practice there could be over 100 factors. The results of these factors have a significant impact on the value of the company and are all related to business risk.

Relying on guesswork

Business valuation is a complex science that requires extensive information gathering, due diligence and industry knowledge to provide an accurate value proposition. Due to the limitations of basic business valuation calculations, the following or similar assumptions are often made. These assumptions may or may not be true and depend on the specifics of each company.

  1. The information provided by the company is materially correct;
  2. The past is a good indicator of future performance;
  3. The economy, industry and geographical location are stable;
  4. Key customers, suppliers and employees support the transaction;
  5. All transactions between the parties are equal in value except as specifically specified in the amendment;
  6. This includes all inventory, plant, equipment, supplies and equipment necessary for the operation of the business;
  7. All downgrade values ​​are just records and the property doesn’t need major renovations in the near future; SY
  8. All necessary intangible assets are transferable.

How to calculate goodwill

Goodwill is the difference between the value of the business and the value of identifiable tangible assets (excluding bank loans and other borrowings). If the realizable value of your substantial goodwill is greater than the tangible assets, but otherwise, if the realizable value is less than the realizable value of the business- hands, the company may have bad goodwill and only the assets retain realizable value. .

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