Business owners assume that they should care on business functioning and does not give much attention to the worth of business. In the current scenario of high competition and emergence of new start-ups, it is necessary to calculate a value of the business from time to time to analyse the growth of a business, like where your company has been, where it is today and where it should be in future.
Business Valuation is a performance analysis tool that helps to determine true business potential which is a pre-requisite for intelligent decision making like choosing investments for a portfolio, in deciding the sale or purchase of business, financing and dividend choices when running a business.
For start-ups, their business valuations are based on financial projections which help them to identify how much investment is required to bring in over a specific period of time. For existing businesses, valuation is done on the basis of historical data and future projections.
In this approach, valuation of an asset is done by comparing it with the value of similar product available in the market. Fair market value is calculated in this approach, which is the business price that a willing buyer will pay, and a willing seller will accept for business. If you are willing to sell your business then you will check the market to know what similar businesses sell for.
The income approach takes into account only the ability of business to produce wealth in future and risks present which will give its true value. It is further differentiated in two methods which are capitalisation method and discounting method. In capitalisation method business earnings are divided by capitalisation rate which helps to give value for a business. The discounted method works differently: at first, projected business income stream over a period of time is measured, then you determine discount rate which reflects the risk of getting this income.
This approach focuses on assets and liabilities value that every business has and by differentiating both will give an overall value of a business. This may sound simple enough but the challenge comes while selecting what asset and liability are suitable for valuation for differentiation and also recorded value of an asset may be different than an actual market value which will change the overall business value.
Its true that business value provides various benefits and ease in the functioning of business but despite these facts, while calculating valuation is not 100% correct and entrepreneur has to take some decisions on their own gut feeling. An entrepreneur is the one who starts a business taking all risk on his own, so if the business is successful then he might have a good sense of decision making. Relying only on business value for decision making is not right, an entrepreneur should consider all those facts that affect business functioning like business value, gut feeling, economic and social factors before taking any huge step.