Business valuation is part science and part art.
With respect to valuing a business according to its profit, the science is in determining what the profit is, and determining the range of multiples of that profit. The art is in using one’s experience but also data to determine where the multiple sits in that range.
When you are talking about a business making no profit, the task is to value the assets according to the most appropriate method. This video shows you how.
The first thing that needs to be answered is ‘does the business make any money?’ If ‘no’ then does the business have any special value? If ‘no’ again then we look at asset value methods. These consist of the depreciation method, the net realisable value, going concern value and the cost to create method.
In the circumstance that the business is making money then we again need to find out if there is any special value, we do this at every step. If there is no special value then we go onto the income method. We look at two different methods here: 1) where the business makes wages and 2) where the business makes wages plus profit.
- In the case the business is just making wages we apply a PEBIT (Proprietors Earnings Before Interest and Tax) multiple. This is usually a smaller multiple because owner’s wages are included in this.
- In the case the business is making wages plus profit we apply an EBIT (Earnings Before Interest and Tax) or EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortisation) multiple.
- Most of the time an owner will be dealing with the capitalisation of future maintainable earnings.
- In cases where capitalisation of future maintainable earnings is not suitable we use a discounted cashflow method. You need to project income and expenses into the future for multiple years.
- The super profit method is also sometimes used.
Business valuers also use methods to cross check their valuation such as the rule of thumb method and the market method.