The valuation of a business is an important exercise when an entrepreneur plans to buy or sell his business. It becomes necessary for most small businesses to calculate the value of their business for many purposes, which include valuation of loan application, estate planning, net worth calculation, and so forth. There are various methods for valuing business: the rule of thumb method, asset valuation or industry average valuation method.

The rule of thumb method involves a factor, or multiplier, to calculate the worth of a business. The same is projected upon a cash flow or profitability figure. The determination of the multiplier is also termed as EBIT (Earnings Before Interest and Taxes.) The profitability and cash flow of a business can also be calculated by a method called owner benefit. The method ascertains the discretionary cash flow that a business would expect in a span of one year. Discretionary cash flow determines the position of the money that would be available for paying business expenses and generating profit.

Asset valuation deals with businesses that are asset-driven for the likes of retail stores, manufacturing companies, wholesalers and the like. The valuation depends on accurately determining the value of the assets in the business. To determine the value of the business, asset valuation is added to owner benefit. Under the industry average valuation method, a study is undertaken of the business, which is in the same industry and has been sold in the recent past. The method helps the seller to reach a ballpark figure for estimating the true worth of the business. Normally, some of the factors that can affect the comparison are location, quality of asset, entry barrier and so forth.

Business valuation is very important for a business owner as it gives a clear picture of the company’s strength, weaknesses and progress. Determining the value of a business is considered necessary for various purposes such as estate planning, business succession planning, loan application, buy-sell funding, charitable giving and financing. In order to optimize business value for future sale, business valuation planning is necessary. It is very useful for business owners who want to prepare their business for sale, market their business to buyers, and facilitate the transfer of ownership of their business. A business valuation prepared before a liquidation event helps the business owner to save both time and money. So, a proper business valuation planning is crucial.

There are several business valuation techniques, ranging from simple business valuation methods to more complex processes that include asset valuation and industry average valuations. Income approach, asset approach and market approach are the three main approaches that determine the value of a business. Before applying a particular business valuation method, the appraiser should adjust the income statement and subject balance sheet.

Certain business valuation techniques give importance to the future, while others place emphasis on historical performance. If the business is valued for sale, then an appraisal that gives importance to future earning power would result in a higher estimated value than one that emphasizes historical performance. The earning power may be measured as net income, operating income or cash flow. On the other hand, if the business is valued to establish estate, gift, inheritance or ad valorem taxes, then a conservative estimate based on historical earnings will result in a lower value. The help of professionals including business brokers, business advisors or certified public accountants is essential for an accurate and reliable business valuation. Today, an assortment of business brokerage companies provides consulting services to make your business flourish.