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Business Value

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In management, business value is an informal term that includes all forms of value that determine the health and well-being of the firm in the long run. Business value expands concept of value of the firm beyond economic value (also known as economic profit, economic value added, and shareholder value) to include other forms of value such as employee value, customer value, supplier value, channel partner value, alliance partner value, managerial value, and societal value. Many of these forms of value are not directly measured in monetary terms. Business value often embraces intangible assets not necessarily attributable to any stakeholder group. Examples include intellectual capital and a firm's business model. The balanced scorecard methodology is one of the most popular methods for measuring and managing business value.[1]


Business Value Calculator
The value of a business can be expressed as the present value of expected future earnings. It is possible to determine the value of a business today based on discounted future cash flows with consideration to "excess compensation" paid to owners, level of risk, and possible adjustments for small size or lack of marketability.


Business Value Formula[2]
A computational procedure used to determine the value of a business. Business valuation formulas are the computational building blocks that power each valuation method. Each approach offers a different view of what a business is worth. To actually calculate the business value, one can select a number of business valuation methods. The value of any business can be determined three ways, formally known as the business valuation approaches:

  • Market Approach - The methods under the market approach typically use a number of valuation multiples. These multiples are ratios that relate the business market value to some measure of the company’s economic performance. Valuation multiple formulas derived from similar business sales offer a quick way to calculate business value – based on the actual selling prices of businesses that are similar, but not identical, to the business. To get an accurate estimate of what a business is worth on the market, one may use a number of such business valuation formula multiples and determine the business value in relation to its revenues, profits, or assets.
  • Income Approach - The income valuation methods offer you a way to calculate business value based on the company’s earnings prospects and risk. All income business valuation methods fall into two main types:
    • Capitalization methods
    • Discounting methods

The choice of the business valuation formulas also differs, depending on the valuation method that is chosen. For example, the capitalization formulas involve the division of business earnings by the so-called capitalization rate. This can also be accomplished by using an earnings multiplier, such as with the Multiple of Discretionary Earnings business valuation method

  • Asset Approach - Asset valuation methods let you determine the company’s worth based on the values of its assets and liabilities. The main asset valuation methods are:
    • Capitalized Excess Earnings Method
    • Asset Accumulation Method

The Capitalized Excess Earnings method uses a number of business valuation formulas to calculate the business worth as a sum of its tangible assets and business goodwill.The valuation formulas for the asset accumulation method are essentially a set of adjustments that is made to the book values of the business assets and liabilities.The goal is to start with the company’s accounting balance sheet, and then determine the true market values of its assets and liabilities. These values often include important off-balance sheet items such as the internally developed intangible assets and contingent business liabilities.


Business Valuation[3]
Depending on the reason for valuing a business, there are several options for coming up with a basic company worth

Types of Assets and Liabilities Before performing any valuation of a business, it’s important to know how to evaluate the different assets and liabilities. Some of these may not be included in a quick valuation. Tangible assets are items that can be sold or disposed of reasonably fast, such as equipment, inventory, cash, investments and receivables. Intangible assets include goodwill, patents, trademarks, company name, logo, recipes, zoning variances, code exceptions, and other assets that have value to a specific business or buyer, but may not be easy to sell in the general marketplace. Liabilities include payables, mortgages, loans, leases, contracts and debt.

Quick Valuation The simplest way to value a business might be to look at its balance sheet. This is a list of the business’s assets and liabilities, showing the company’s net worth. Depending on the business, the balance sheet might show tangible and intangible assets and a variety of long-term liabilities, some of which might be reduced through negotiations and invoking early-termination agreements. If it’s a complex balance sheet, the assets can be sold quickly and the liabilities subtracted to determine the company’s net worth for a fast sale.

Earnings Multiplication Another way to value a business is to multiply the annual earnings, based on how long it is perceived the company will operate. This number is known as a multiplier of earnings. For example, a business that has made a profit of $100,000 annually for the last three years and is situated to continue successfully for the foreseeable future might sell for three to five times earnings, or $300,000 to $500,000. This is a very subjective way of calculating a business, and depends on the buyer’s confidence in being able to decrease costs, increase sales, and keep the business running well beyond the investment payback period. Professional business brokers are often skilled at valuing a business based in part on earnings.

Complete Valuation To determine the most accurate value for a business, consider all of its assets, liabilities, recent earnings, future potential, and the skills and abilities of the buyer. If one is looking to buy a business to break it up and make a profit from the sales of its assets, a thorough appraisal and evaluation, of all of the business’s tangible and intangible assets, must be conducted and determination of reduction of any liabilities through negotiation with creditors. Liquidating a business might require discounted assets for quicker sale and offer creditor concessions, such as early payment, for discounts.


See Also

Business Strategy
Business IT Alignment
Business Capability IT Strategic Planning IT Value Business Value of Innovation
Business Value of Information Technology (IT)
Business Value Index (BVI)

References

  1. Definition of Business Value Wikipedia
  2. Business Valuation Formula ValuAdder
  3. Formula to Determine the Value of a Business Chron


Further Reading