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Calculating the Value of Your Business
There are a number of ways to calculate the value of your business. One way is to simply tally up the value of your company's assets. A second way is to compare your business to similar businesses that have sold recently. A third way is to simply assume your company is worth some multiple of your revenue. However, the only method I recommend using to calculate the value of your business is to calculate the value of future cash flows. A brief discussion of the different methods follows:
Calculating the value of your business by adding up the value of your assets
Adding up the value of your assets is a very simple way to calculate the value of your business. Simply add up the value of your hard assets (equipment, machinery, real estate, cash) and subtract any liabilities. The advantage of this method is that it is simple and presumably sets the minimum value of your business. You should be able to liquidate the company and get this value. The disadvantage of this method is that it doesn't assign any value to the company's future earnings potential.
Calculating the value of your business by comparing it to similar businesses
Another simple valuation technique is to compare your business to other similar businesses which have sold. If you can find similar businesses, this can be a great method. However, finding a business that is truly similar can be very difficult. Even two businesses in the same geographic region and industry with the same revenues and profit margin could be worth different amounts to different acquiring companies based on things like the management team, the company culture, and what is actually driving profits. Therefore, if you can find a business you really think is similar, then I recommend using this method as a way to calculate the value of your business. However, I think it is important to think hard about how your company is different than the one you are comparing it to before placing much stock in the value you come up with.
Calculating the value of your business by taking a multiple of revenue
I have often heard people claim that their company is worth a certain amount based on taking a multiple of their revenues. For some industries this might provide a ballpark number, but it is at best a ballpark number. A company's real value comes from its ability to generate profits, not revenues.
Calculating the value of your business by calculating the value of future cash flows
The best way to calculate how much your business is worth is to calcualte the discounted value of future cash flows. This is the most complicated method because it means making detailed projections of revenue and expenses for future years, which inevitably means multiple assumptions. However, this method is definitely the best method of determining what your business is worth to you. You can't know what someone who acquires your business will do with it and therefore can't very well project what it is worth to them. However, you do have a good idea as to what you will do with your own business and therefore can figure out what it is worth to you. In addition, because you will be making all the assumptions, you should end up with a good gut feel as to how accurate they are, so you end up with a value and a good idea if the value is conservative, realistic or optimistic.
Finally, if possible it is great to use multiple methods to calculate the value of your business, and then to compare the different results. There is no correct answer as to what the value of your business is. Two separate entities considering purchasing your business might come up with very different offers based on different methods of valuing your business, different assumptions about what will happen in coming years and/or different plans as to what they will do with your business. In addition, companies make acquisition mistakes all the time, which underscores just how difficult it is to calculate the value of a business. For this reason, I recommend focusing first on what your business is worth to you. Once you understand this, you are in a good position to negotiate with a potential acquirer.
