What is your business worth? This is a question many business owners as well as a wide spectrum of tax and financial professionals frequently ask. Whether you are a small start-up or a booming enterprise knowing how to benchmark your business value is very important. With public companies, it’s easy to determine a benchmark based on share prices and market capitalization on public stock exchanges. However, for private companies, it’s not that simple, but just as vital.
One way to determine the value of a business is by bench-marking – that is selecting valuation multiples and measuring them against comparable companies. When looking to know your business value a qualified business appraiser is most useful. They use their professional judgment, experience, and analysis to determine fair market value. For additional questions, reach out to Peak Business Valuation by scheduling a free consultation.
Financial Metrics
To determine a benchmark, appraisers or business valuation analysts typically consider three financial metrics:
- Revenues: The total amount of money generated by a business’s activities. This is sometimes referred to as the “top line” because it does not deduct any expenses.
- EBITDA: This is an acronym for earnings before income, taxes, depreciation, and amortization.
- Seller’s Discretionary Earnings (SDE): This metric shows the earnings of an owner. The calculation is EBITDA plus the owner’s salary.
Other ratios used include profitability ratios, liquidity ratios, solvency ratios, and efficiency ratios.
How to Obtain a Benchmark
To get a benchmark value of the business you compare the above financial metrics to metrics of similar selling businesses. These financial metrics are often converted into ratios to help equally compare companies of different sizes. The key to benchmarking is to consider a group of businesses in an industry. Then take the median or middle of the set of numbers. The median is preferable as it eliminates outliers which may skew the average.
Business appraisers typically use median (and sometimes average) selling price ratios for the industry to create a general ballpark for the company requesting a valuation. They then apply a weight to each estimated value to determine a final value. Depending on the situation, revenues or EBITDA may be more important than SDE so more weight may be applied to that value.
Industry Benchmarks
One benefit of using a qualified business valuation specialist is their access to industry benchmark data. Business appraisers have access to databases that detail the financials of private businesses. These databases are often organized by industry. The appraiser can then compare selling price ratios of specific business types to other businesses in the same industry. In addition, to general industry data, the database can also narrow the search to specific business types in that industry. For example, construction contractors are a general industry with HVAC contractors being a segment within the industry.
Summary
Valuing your business is useful for strategic planning, exit strategy planning, and tax planning. In addition, if you are a business owner looking to buy or sell in the near future obtaining a business valuation can help you determine a reasonable transaction price.
Peak Business Valuation loves to help business owners know and understand the value of their company. We also provide valuable insights into growing the value of your business. We welcome any questions you may have. Please reach out by scheduling a free consultation.
