How to Value a Business
Businesses can be valued in a number of ways, including Net Tangible Assets, Capitalised Future Maintainable Earnings, Discounted Cash Flow, Net Realisable Value, and various others. Some industries (such as real estate and accounting practices) have developed a short-hand valuation method over time, often referred to as an Industry Rule of Thumb. The most commonly applied valuation methods for small businesses are the Net Tangible Assets and Capitalised Future Maintainable Earnings.
Capitalised Future Maintainable Earnings Business Valuation Method
This method places a value on shares or a business by estimating the likely Future Maintainable Earnings (FME), capitalised at an appropriate rate which reflects business outlook, business risk, investor expectations, future growth prospects and other entity specific factors. This approach relies on the availability and analysis of comparable market data.
The FME approach is the most commonly applied valuation technique and is particularly applicable to businesses with relatively steady growth histories and forecast, regular capital expenditure requirements and non-finite lives.
The FME used in the valuation can be based on net profit after tax or alternatives to this such as EBIT or EBITDA. EBIT multiples can range from 0.8 times FME to over 5 times, depending upon the industry, performance, and relative risk of the subject business.
Net Tangible Assets Business Valuation Method
The Net Tangible Assets method is usually appropriate where there is no goodwill in a business or where the majority of assets consist of cash or passive investments. All assets and liabilities of the entity are valued at market value and this combined market value (less any debt) forms the basis for the entity’s valuation.
Often the Capitalised Future Maintainable Earnings or Discounted Cash Flow methodologies are used in valuing any goodwill component of a business for inclusion in a Net Tangible Assets valuation.