What a company is worth is not the cash in the account or what it cost to set up. It is what an informed buyer would pay today for the money the business can generate. There are three usual ways to estimate it, and it is worth looking at more than one.
Why a number is useful
It is useful before a sale, before bringing in a partner, before spinning off a branch or before thinking about succession. It is also useful so you do not accept a hallway price. The useful figure is a range, not a round number for the listing.
Discounted cash flow
This method adds up, in today’s value, the cash the company could hand to its owners over the coming years, after reinvesting what the business needs to keep operating.
It carries more weight when there is a track record and a credible forecast. If the projection only holds because of a sales jump nobody has seen, the value is inflated and any buyer will cut it back.
Risk shows up in the rate. A business concentrated in one customer, or tied closely to one person, requires a higher return and is therefore worth less than one with repeat revenue and a team that operates without the owner.
Market multiples
Here the company is compared with similar businesses that have already been sold or that are listed, and a multiple is applied to a figure from the business, for example sales or operating profit.
It is quick and easy to explain. It is also easy to misuse. A multiple from another industry, another size or a boom year is not yours. The multiple changes with the sector, growth and debt.
Asset value
It subtracts debts from assets. It is a floor, useful when there is property, machinery or inventory with a market. In a services company, where the value sits in customers and in the craft, this method falls short because it cannot see what is not on the balance sheet.
Which method fits the moment
- A company with a track record and stable cash flow. Discounted cash flow leads, and the multiple is the cross-check.
- A young business, or one that depends heavily on the owner. Any method needs a discount for that risk. Asset value does not correct for it.
- A sale, a partner or a succession. Present a range from two methods and explain what moves it. A single closed number invites a negotiation at the extreme.
If the conversation is a sale or a succession, the range is discussed together with the company valuation and, when it is time, with the sale of the business.
In practice
If the value only exists because the owner works every hour, the buyer will discount it. Getting operations in order before you ask for a price usually moves the range more than fine-tuning a formula.
