Business Evaluation

Evaluating the performance of any business is an essential practice that helps to identify potential problems in a business, and noting both positive and negative trends within business activities. By undertaking regular evaluations, the progress of the business activities will be clarified and adjusted if necessary, allowing owners and managers to make practical decisions for the successful growth of the business.

Each business and industry is unique and the key goals and ambitions for each business will vary. But there are some common issues we always look at when evaluating a business”

  • How does the business operate?
  • What are the key goals for the business?
  • Is there current financial information available?
  • Has the business met its financial obligations such as debt repayments?
  • Has the business met its taxation obligations, such as completing BAS statements?
  • Are there any human resources challenges?
  • What are the strengths and weaknesses of the business?
  • What opportunities does the business have available?

The Benefits of Business Evaluation

  • Get real evidence on the operations of the business
  • Be more proactive in decision making
  • Understand the environment in which the business is operating
  • Understand what external factors will impact the business

How are Business Evaluations Undertaken?

There are several formulas you can use, and here are the most commonly used formulas.

  1. Asset valuation
  2. Capitalised future earnings
  3. Earnings multiple
  4. Comparable sales

Asset valuation method

  • Adds the value of the assets of the business and subtracts its liabilities
  • Determines what the business would be worth if it were closed down today and sold
  • Doesn’t take into account the ability of those assets to generate wealth in the future
  • Doesn’t take into account goodwill
  • For these reasons, asset valuation may understate the true value of the business

What about goodwill?

  • Goodwill is the difference between the true value of a business and the value of its net assets
  • It can be crucial to the value of retail and service-based businesses
  • Goodwill may or may not be transferred if you buy a business, since it can come from physical features like location, or from personal factors, like the owner’s reputation or relationships with customers or suppliers

Capitalised future earnings

  • When you buy a business, you’re buying its assets and the right to all profits the business might generate
  • Capitalising future earnings is the most common method used to value small businesses
  • It considers the rate of return on investment (ROI) that you can expect to get from the business

 

Earnings multiple

  • Multiply the business’ earnings before interest and tax (EBIT) by your selected multiple
  • For example, you might value the business at twice its annual earnings – so a business with an EBIT of $200,000 might be valued at $400,000
  • The multiple you choose will depend on the industry and the growth potential of the business
  • A service-based business might be valued at as little as one year’s earnings, while an established business with sustainable profits might sell for as much as six times earnings

Comparable sales

  • Whatever other valuation method you use, you should also look at prices for recent sales of similar businesses
  • Research what’s happening in the market you’re interested in
  • Speak to business brokers and gauge their feelings about the business’ value
  • A broker may know what similar operations are selling for and how the market is placed
  • Check business-for-sale listings in industry magazines, newspapers or websites

We can help you with business evaulation, whether it’s because you want to buy a business or because you want to improve your own business. Contact us today to find out more.