Valuing a business to buy or sell
There are many reasons why you might want to know the value of your business. You might, for example, want to determine your own net worth or use the valuation to secure finance, attract investors, or sell your business. This guide provides an overview of business valuation for buying or selling a business.
Consider professional advice
You can do your own business valuation, but buyers and sellers often have different ideas about what a business is worth. It's therefore a good idea to engage a business broker or professional valuer to assess a business. They are:
- more aware of current market values
- offer a more complete picture of a business's value.
A well-prepared, balanced and independent valuation can help speed up negotiations and simplify the sales process.
Information needed for a business valuation
To correctly value a business, a business broker or financial adviser:
- will ask to see 5 years (if possible) of financial statements
- will likely want to visit the premises to check operations and the business's tangible assets
- may ask you to send them a video of the assets and business operation if they can't attend your premises.
They will also want information on intangible assets such as:
- intellectual property and trademarks
- the outlook of the industry
- how your business compares to similar businesses on the market
- goodwill and brand recognition.
Refer to your business plan
Your business plan should be able to provide much of the information needed.
If you don't have a documented or complete business plan, read more about preparing a business plan.
Information included in a business valuation
A complete business valuation will be a formal and professional document that answers the following questions.
- Is the valuation for a buyer, seller, lender, investor or other reason (e.g. family estate plan)?
- How long has the business been operating?
- How was the business started?
- What has been the business growth?
- What is the business's reputation like?
- What is the condition of the facilities, plant, and equipment?
- Are there documented position descriptions and employment contracts for all staff?
- Are there any specialist skills required to run the business?
- Does the business rely on specific people to operate?
- What are the current employee pay rates?
- What is staff morale like?
- What is the corporate structure and management of the business?
- Does the business have documented governance, risk and compliance processes?
- Does the business operate with streamlined workflows and systems?
- Is the business involved in any current or pending legal proceedings?
- Does the business comply with human resources, environmental and work health and safety laws?
- Does the business have any long-term commercial contracts? How long are these valid for and how much are they worth?
- Does the business have the necessary licences, permits and registrations? For how long will these be valid?
- What lease arrangements does the business have for business premises?
- What marketing strategies are in place?
- Is the business making a profit?
- Is there working capital or sufficient cash flow?
- If the business applied for finance, how much can the cash flow support?
- What has the annual turnover been for the past few years?
- Have the turnover and profit increased, decreased or remained the same?
- If there have been spikes in the increases or decreases, what caused them (e.g. COVID-19)?
- What tangible assets, such as machinery, buildings and equipment, does the business have?
- What is the market value of these assets in their present condition?
- What liabilities, such as unpaid creditors and loans, does the business have?
- Does the business have enough working capital to pay shareholder dividends?
- What is the book value of the stock (rather than the retail selling price)?
- What proportion of the stock is obsolete or unsellable?
- What is the short-term and long-term industry outlook?
- Will specific economic factors directly affect the business?
- Is this market growing, steady or shrinking?
- Who are the business's competitors?
- Are there any barriers to entry?
- What market share does the business have?
- What is the market price of similar businesses?
- What competitive advantages does the business have?
- What will be the impact, if any, of the departure of the current owners/managers?
Different approaches to valuation
Business valuations are usually based on a combination of methods. These methods are selected based on the valuation approach. There are generally considered to be 3 valuation approaches. A valuer will decide on the approach they believe will give you the best outcome.
This approach looks at recent transactions involving businesses (or assets) that are identical or comparable to yours. It uses this information to calculate a value for your business.
This approach looks at a business's past and current performance to estimate the future income and risks of a business.
This approach values a business based on the value of its assets minus its liabilities. It reflects the amount that would be required to create a similar business or to replace the current capacity (productivity) of the assets.
Common valuation methods
Your broker or agent can help you choose the most appropriate method, or a combination of methods, for valuing your business. The most common valuation methods are briefly discussed below.
This method can depend heavily on:
- your industry
- seasonal trends
- the current market value of similar businesses in your industry.
Industries usually have their own formulas or ratios to value businesses.
This method uses the business's net profit to calculate its value around your ROI expectations. You can choose to:
- see what your ROI will be if you sell it for the price you have in mind
- calculate your selling price based on the ROI you want to get.
You can use the 2 ROI-based calculators below to get these answers.
It can be difficult to justify the price you want to sell your business for. Calculating the cost of creating the business from scratch can help to validate the value. Include all the costs that would be involved in starting your business to calculate this value. Some of these are:
- buying stock, tools, machinery and equipment
- licence and permit fees
- cost of recruiting, training and employing staff and contractors
- fees paid to consultants, advisers and coaches
- cost involved in research and development of your products and services
- investment in branding, marketing and promotion
- software subscription fees
- cost of buying or leasing business premises
- investment in establishing your online presence, including websites, social media and search engine optimisation (SEO).
The net worth of a business is essentially the difference between what it owns (assets) and what it owes (liabilities).
Formula: Net worth = Assets - Liabilities
When calculating a business's net worth, you need to consider:
- tangible (current) assets: assets with a clear, easily measurable value that can be converted into money in a short period of time, such as tools, cash, inventory and accounts receivable
- tangible (non-current) assets: long-term investments, such as property, equipment and machinery
- intangible assets: assets that aren't physical, such as intellectual property, goodwill, trademarks and quality of brand.
An agent or broker will consider the assets:
- age, relevance and currency
- current condition
- replacement value versus the market value of the asset in its current state
- contribution or impact on the business's ability to perform.
Market value of assets
This is the estimated value of a business asset if it were to be sold on the open market in its current condition. Market value is based on:
- the value of the asset to the operation of your business
- the price a seller and buyer would agree to if the asset was sold as an independent item.
Insurance companies will usually ask you to choose between the market value or replacement value of an asset when insuring it.
Valuing current assets
Current or short-term assets include:
- accounts receivable
- stock inventory
- security bonds or bank guarantees
- other liquid assets (assets you could reasonably expect will be converted into cash within 12 months)
To value current assets, you'll need to review the business's stock on hand and balance sheet.
Your financial adviser or accountant can help you value the current assets of a business.
Valuing non-current assets
Non-current or fixed assets are long-term or permanent business assets. Non-current assets include land, buildings, plant and machinery, tools, motor vehicles and computer equipment.
Non-current assets are usually valued by deducting the accumulated depreciation from the original purchase cost.
For example, if a business bought a computer 2 years ago for $2,100, this is a non-current asset and it's subject to depreciation. If the accumulated depreciation for the computer is $1,000 over the 2 years, then the value of the asset now is $1,100.
Sometimes, the depreciated value of a tangible asset is quite different to its market value. It's important to verify the market values, particularly for high-value assets.
Valuing intangible assets
Intangible assets play a major role in valuing a business. They include:
- patents, trademarks and copyright
- customer and membership databases
- performance of branding and search engine optimisation
- strength of reputation and goodwill
- intellectual property (IP).
IP is difficult to value as it doesn't depreciate in the way that a tangible asset does. You should consider seeking professional assistance to value intangible assets.
To value the goodwill in a business, look at aspects including:
- how strong your market position is
- the physical location of your business (the better the location, the higher the value)
- the quality and longevity of your clients (high-value clients and repeat clients increase your business's goodwill)
- the value and remaining term of any signed contracts
- how strong and positive your business reputation and brand name is, both online and offline.
- valuing a business's intangible assets can be difficult
- it doesn't consider the premium that might be justified for strong-growth businesses, or discounts for businesses that are in decline.
Potential buyers and investors usually prefer to buy a business based on the value of its historical and future profits. The best way to show this is through your:
- financial statements
- financial forecasts.
You can use this value when:
- negotiating for finance
- deciding the selling price for your business.
A basic formula can be used to value your business based on annual net profit, but you'll also need to consider factors such as:
- the current market.
Key concepts in valuing a business
The following are some key concepts you will need to understand when valuing a business.
Owners who work in their business are entitled to a fair salary for their work. A fair salary for the owner is the amount you would pay someone else to do the hands-on work that you do in the business. This amount would include superannuation.
When you're valuing the business, make sure you know if a fair salary for the owner is taken into account and subtracted from the annual net profit.
For example, you're considering buying a business for $200,000 and the valuation gives the annual net profit as $100,000. Given the hours you'd need to work in the business, assume a fair salary would be $90,000. If the owner's salary has not been subtracted from the annual net profit, it can give a misleading idea of your expected return on investment.
|Variables||Owner's salary deducted||Owner's salary not deducted|
|Stated annual net profit||$100,000||$100,000|
|Owner's salary deducted||Yes||No|
|Annual net profit||$100,000||$10,000|
If you have a sum of money to invest, you'll expect a return on it. If you put it in a bank, you'd get a certain return on that investment (ROI).
If, instead of putting your money in a bank, you invested it in a business, the return you'd expect to make would need to be greater because the risks are higher, and you'll be investing more time and effort.
Fair ROI refers to the return you expect to receive in the current marketplace for a riskier investment than putting funds in a bank.
The fair ROI you'd expect would be in direct proportion to the risks involved. For example, if you invested in a very speculative business venture with a high degree of risk, you'd expect a very high rate of potential return if it was successful.
A specific example of fair ROI is fair return on net tangible assets. This is the return you'd expect from the net tangible assets of a business.
Net tangible assets include only tangible asset minus liabilities.
For example, a business has:
- tangible assets of $200,000
- liabilities of $80,000
- intangible assets (including goodwill) totalling $20,000.
The net tangible assets of this business are:
- $200,000 minus $80,000, or $120,000.
The fair return on net tangible assets you'd expect to get from this business, assuming you have an expected ROI of 20%, would be:
- 20% of $120,000, or $24,000.
Super profit is the excess a business might return financially after you have taken out fair salary for owner and fair return on net tangible assets.
It's the amount you'd expect to receive from the business after deducting what you would have received if:
- you were a paid employee in the business
- you had invested the money you'd spend on the net tangible assets elsewhere.
Use the following interactive calculator to help you work out the super profit relevant to your business. Enter the numbers that are relevant to your business into the calculator to determine the value of your super profit.
Super profit calculator
- Last reviewed: 24 Oct 2022
- Last updated: 24 Oct 2022