Whether you’re selling your business, buying another, preparing financial reports, or even going through a divorce, knowing the exact value of your business is essential. Below are some general tips and key approaches that may guide you through the valuation process.
The value of a business is driven by different factors including profitability, assets quality, and associated business risks. There are also often intangibles – such as customer lists, long-term contracts, intellectual property, and brand reputation – that may not been recognised in the financial statements but still hold significant value.
Common methods
There are three common approaches in business valuation:
- Multiples approach
- Discounted Cash Flow (DCF) approach
- Asset-Based Valuation approach
The best method to use will depend on the specific business and its industry.
What is the Multiples approach?
The multiples approach (also known as the comparable method) utilises financial metrics from comparable businesses — earnings before interest, taxes, depreciation, and amortisation (known as EBITDA) to value a business. Comparison using the EBITA method can determine a fair value for its enterprise or equity.
You often find the multiples approach used by service organisations and small to medium enterprises (98% of businesses in Australia), as these businesses can lack significant tangible assets and may not have detailed financial projections readily available.
Let’s say you are valuing a construction business with an EBITDA of $3 million. You have identified that the comparable construction companies trade at a multiple of 3.5x EBITDA, the estimated enterprise value would be $10.5 million (before factoring in debt, cash, or other adjustments).
How do you identify comparable companies?
In the multiples approach, the identified comparable public companies are typically publicly listed firms in stock exchanges (e.g. ASX). Conversely, private companies involved in recent mergers or acquisitions can also serve as comparables.
What else should you consider for the multiples approach?
While it is common or the multiples approach to be used, no two businesses are the same. Here are other factors to consider when using this method:
- Is the comparable company a similar same size as the business being valued (with respect to the relevant financial metrics)?
- Are the business’ shares as liquid as the comparable companies?
- Do they operate in the same geographic or market segment?
- Is the business overly reliant on a single person?
- How easily can the business secure external funding?
- What are the projected maintainable earnings of the business?
These considerations should be reflected in the final valuation and require the application of professional judgment to ensure an accurate reflection of the business’ value.
The Discounted Cash Flow approach
The Discounted Cash Flow (DCF) method values a business based on its anticipated future cash flows, adjusted for the time value of money using a discount rate that considers the company’s risk. The DCF approach is more comprehensive but requires reliable financial projections and assumptions about growth and risk, so is more suitable for businesses with stable and predictable cash flows.
The Asset-Based Valuation approach
The asset-based approach values a company based on the net worth of its assets.
This method is often used in industries with substantial physical assets or in cases of liquidation. It may be less suitable for service-based businesses with few physical assets but can be crucial in specific cases, such as when valuing real estate or manufacturing companies.
How to start the valuation process
The first step is to gather the relevant data for the valuation process, including:
- Historical financial information including balance sheets, income statements, and cash flow statements. (Note – these results may need to be normalised to exclude non-recurring / one-off items)
- Future financial projections
- Important information from management about unusual events or one-time revenue and expenses that may have affected past financial performance.
How HLB can help
While businesses can perform their own valuations, hiring a qualified experienced adviser brings the benefit of an independent and objective perspective.
A qualified valuation professional can provide the impartiality needed to avoid biases and ensure a credible, defensible valuation. External advisers can also tailor the type of valuation to your specific needs such as:
- Financial reporting
- Tax compliance
- Merger or acquisition
- Portfolio asset valuation
- Independent expert reports.
We have extensive experience helping business owners, management teams, and consultants conduct independent valuations. Our team works closely with clients to deliver clear, timely, and accurate valuation reports tailored to their unique circumstances.
Whether you’re preparing for a sale, restructuring, or needing compliance-based valuations, we provide the clarity and confidence you need to make informed decisions.
If you want to learn more about valuations, please check out our podcast series ‘Talking Advisory & Client Solutions’ Episode 2 – What is the business worth here.