How to value a company
Find out how experts put a value on a company. Understanding these methods will help when it’s time to sell yours.
What is a company valuation?
A company valuation estimates the monetary worth of your business. It doesn’t set or guarantee a sale price, but the number can be used for financial reporting, seeking finance, and as a negotiating point should you sell.
How to value a company
1. Book value calculation
A company's book value is worked out using the assets and liabilities listed on its balance sheet.
Book value formula
Book value = Assets - Liabilities
In other words, it's the net value of everything the company owns after debts are subtracted.
Assets include property, inventory, equipment, cash reserves, accounts receivable, and intellectual property like patents. Liabilities encompass debts such as loans, unpaid taxes, and accounts payable (bills you owe).
If a business owned £10m in assets and owed £5m in debts, the book value would be £5m.
2. Liquidation value calculation
Liquidation value is similar to book value, but it uses the current market value of all assets rather than the recorded book value. It asks what owners would be left with if they sold off all assets and repaid all debts.
The subtle distinction from book value matters because the market value of assets can fluctuate. For example, a temporary change in demand, increased competition, obsolete technology, or market disruption can all affect the money you’d actually get when selling assets.
Liquidation valuation formula
Company value = Liquidation value of assets – Liabilities
3. Multiply company earnings
Another approach values a company as a multiple of its annual earnings.
Earning-based calculation formula
Company value = Earnings x Multiplier
The key variables here are the earnings figure used and the multiplier. Earnings could be either net profit or EBITDA (earnings before interest, taxes, depreciation, and amortisation.
Meanwhile, the multiplier can range from 2x to more than 10x. Bigger multipliers are given to businesses with loyal customer bases, market exclusivity, protected intellectual property, and other hard-to-replicate advantages. There are often standard multipliers for certain industries.
4. Multiply company revenue
Like the earnings-based approach, this method uses a multiplier formula. However, instead of applying the multiplier to profit, it applies the multiplier to revenue. This is also called a times-revenue valuation.
Times-revenue formula
Company value = Annual revenue x Multiplier
As with the earning-based calculation, the multiplier plays a big role in your final valuation. There are often accepted industry-specific multipliers. A local accountant or business broker will know the multiplier range for your type of business.
5. Multiply free cash flow
You can also value a company by examining free cash flow, which is the money left after meeting business costs and planned capital expenditure.
Free cash flow formula
Company value = Free cash flow x Multiplier
This can be a handy way to value a business that needs upgrades, such as new equipment, a shop refit, or a digital makeover. It shows if the business can fund those improvements over and above its usual operating costs. Calculating a company's free cash flow requires complex analysis to determine what capital expenditures are needed.
6. Entry-cost analysis
It’s quite legitimate to value a company by working out what it would cost to recreate it. To do this, the valuer will estimate the capital expense of starting from scratch, making adjustments for customer acquisition, brand building and so on. This isn’t how you’d value a company that has lots of hard-to-replicate elements, such as key relationships, proprietary information, goodwill, or other things you can’t simply buy on the open market. But it may make sense for companies that drive value through their assets. For example, it may be relatively simple to replicate a printing company simply by buying a printing press.
7. Market capitalisation
For publicly traded companies, market capitalisation – the total combined value of all the company’s shares – reflects its value.
Share price formula
Company value = Share prices x Number of shares
8. Enterprise value
This method also applies to publicly traded companies. It takes the combined value of all the company’s shares but makes adjustments for debt and for cash held in reserves.
Enterprise value formula
Company value = Market capitalisation + Cash – Debts
This provides a more comprehensive valuation snapshot than the market cap alone for publicly traded companies. This is often used in conjunction with the Debt-to-Equity (D/E) ratio, which is used to understand how much of the company’s operations are being financed with debt rather than cash flow.
Valuing a company is complicated
As you can see, there are multiple approaches to valuing a company. Selecting the right method (and finding the correct multipliers) should be left to professionals. But if you want to know the standard book value, then it’s easy enough to pull from your balance sheet. You can create a balance sheet and pull reports on demand, using software like Xero.
Be aware that none of these methods may align with what you’d get in an actual sale. Valuation can be subjective, especially in negotiations. Regardless of what you believe your business is worth, buyers may or may not be willing to pay the price. However, knowing the value helps guide negotiations.
Disclaimer
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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