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Valuations

There are a number of different ways to calculate the value of a business. We share the most commonly used business valuation methods below.

Earnings multiples

This method is suitable for companies with an established financial history. The price/earnings (P/E) ratio represents the value of the business divided by its after-tax profits. Two factors influence the earnings multiples:

1. The earnings: These should be “normalised” - in other words, all one-off items should be adjusted for - and the best estimate for the next 12 months.

2. The ratio: This should reflect all known risk factors - the higher the risk, the lower the ratio and vice versa - and will be in the range of three to eight for most unlisted companies.

Entry cost

This is the predicted cost to set up a similar business to the one being sold. It includes the cost of developing a customer base and reputation, recruiting and training staff, purchasing assets as well as developing products and services.

Asset valuation

This method is more appropriate for established companies with a large amount of tangible assets, such as property companies. The valuation is made by calculating the net realisable value of all assets.

Discounted cash flow

This method uses an estimate of the company’s cash flow into the future, discounted by a required rate of return. The “terminal value” or residual value of the company is also calculated and again discounted over a fixed period of time. Each year’s cash flow is valued and added to the terminal value to determine a current business valuation.

Industry valuations

In certain industries, when businesses change hands on a regular basis, industry-wide rules of thumb are used to value a company. These valuations are often carried out by recruitment agencies and accountancy firms.

Other considerations

There are also a large number of other factors that may be taken into account:

  • Economic climate
  • Intangible assets
  • Reasons for sale
  • Warranties
  • Due diligence

Contact our accounting advisory team

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Melbourne VIC 3141
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