In any given field, there is a clear distinction between theory and practice. Every university graduate knows this. What was learned in the classroom provides a nice theoretical foundation, but real life practice can be vastly different from the classroom. The same is true in business valuation.
As an M and A consultant with years of experience helping companies figure out their true value, I understand there is room for both theory and practice when valuing a business. Moreover, it is important to weigh them proportionally in order to get a complete and accurate picture.
Business Valuation Theory
A theoretical valuation of business is based on expected future revenues adjusted proportionally to put them in current terms. It is a simple concept that relies mainly on cash flow to determine value. Cash flow takes centre stage because it determines how much capital will be required to keep the business going versus the amount of revenues that will ultimately be counted as profit after all operational costs are met.
The challenge of theoretical valuation is that it does not account for intangible metrics. It is strictly a cash flow measurement that may not tell the true potential of a company, or the lack thereof. This is why practical business valuation is so necessary.
Business Valuation in Practice
A practical valuation of a company accounts for both tangible and intangible factors. Tangible factors are those that are measurable through some tangible, quantifiable means. These include things such as:
- recent sales of similar companies
- earnings posted by similar companies
- historic performance of the company and sector.
Intangible factors are equally important despite not being so easily measured. These include things like:
- buyer perceptions of the company and sector
- strength of existing management
- sector competition and other similar barriers.
The practical value of a business has to look beyond mere cash flow with an eye toward projecting a company’s future based on current operations and future goals. The aim of practical valuation is to do two things. First is coming up with a figure that accurately reflects both the current market and future projections. Second, a practical valuation clearly tells what ownership and management need to do to increase company value should they ever decide to sell.
Knowing the True Value of Your Business
My role as an M&A consultant affords me plenty of opportunities to work with SMEs looking to buy, sell, and expand. I also have the opportunity work with plenty of small business brokers who move millions of pounds of properties every year. One thing we all agree on is the importance of knowing the value of a business before buying or selling.
I can help you determine the true value of your business in both theory and practice. Whether you are interested in selling, you are hoping to buy, or you are just curious about the current market, I am here to help you figure out what it is all worth.
By Tim Luscombe.
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