Elements of Business Valuation

So what are the ingredients that increase business value?

The usual metric employed to value a business is EBITDA (Earnings Before Interest, Tax, Amortisation & Depreciation) with a multiple then applied which typically is 4 (hence 1=4 as for every extra £ of sustainable profit, this increases the business value by £4). This multiple will vary according to how the business meets the criteria below plus whether there is any Intellectual Property. 

  • PROFITABILITY: seemingly obvious but the emphasis here is on SUSTAINABLE profitability. Owners working 24/7, ruining their personal life, & taking Dividend rather than Salary to finance their lifestyle & artificially boost profitability, make the business not attractive to a Purchaser, with the Sale Price reduced accordingly
  • BALANCE SHEET: sustainable profitability must be supported by a strong balance Sheet. This means no over indebtedness, good management ratios (eg Current Asset to Current Liabilities of 2), cash, no Directors Loan arrears, good quality Stock, no aged Tarde Debtors, & no annual overpayment of Dividends leaving working capital stretched.
  • CASH GENERATION: a Purchaser does NOT want to have to continually put more money in for investment. In the current  economic conditions, cash generation is even more key.
  • ABILITY TO RAISE PRICES: the true indicator of a good business is its ability to raise prices to protect or improve profit margins – particularly relevant in an inflationary environment.

This shows a powerful market position & competitor differentiation.

  • GROWTH POTENTIAL: a purchaser will want credible areas for profitable growth. Nobody buys a business to stand still.
  • GOOD MANAGEMENT INFORMATION: good readily available data, not only makes it easier for the existing owner to run the business, but also ensures that there is a potential regular flow of information as requested by a Purchaser for review.
  • MANAGEMENT SUCCESSION: too often Owners neglect to develop their people & especially a Management Team. Without the latter not only are the options for sale reduced for an owner (51% of all businesses under £2m turnover are sold to Management Buy Outs), but also damages a Trade Sale price.
     
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