How to value a business: the main methods

Valuing a business means estimating the price it could reasonably be sold for, and the honest answer is a range rather than one number. The result depends on the method, the information available and the reason you are asking.

HMRC’s valuation manual explains why this is hard for private companies: the actual market for unlisted shares is, at best, fragmented and in many cases does not exist at all. There is no screen showing today’s price, so a valuation is an informed opinion, which is why the method and its assumptions matter as much as the figure.

The three standard approaches are asset-based, income-based and market-based. Each looks at the business from a different angle, so they suit different situations.

A valuer will usually cross-check at least two of these. If they point to very different figures, that gap is useful information in itself, and it should be explained rather than averaged away.

Asset-based valuation adds up what the business owns and subtracts what it owes. The starting point is the balance sheet, though the book figures are normally adjusted, because equipment, stock and property may be worth more or less than their recorded cost.

The table works through the sum for an imaginary business.

This method suits businesses whose value is mostly in what they hold. For a firm whose value is in its customers, staff and reputation, it understates the worth of the trading business, because those things do not appear as assets.

Income-based valuation values a business on what it earns or is expected to earn, on the basis that a buyer is paying for future profit or cash. The measure of earnings you start from matters, and it must be applied consistently.

• Net profit: the bottom line after all costs, covered in our guide to net profit.
• EBITDA: the British Business Bank’s glossary calls it a form of operating profit, standing for earnings before interest, taxes, depreciation and amortisation. See what EBITDA is and how to calculate it.
• Cash flow: the cash the business generates after the spending it needs to keep going, as in free cash flow.

A discounted cash flow valuation forecasts the cash the business will produce in future years and reduces each year’s figure to its value today, because money received later is worth less than money in hand. The method is only as reliable as the forecast. Small changes to growth or to the rate used to discount can move the answer a great deal, so a valuer should show what happens under different assumptions.

Earnings are usually adjusted before they are used. One-off items, an owner’s unusually high or low pay and costs that will not continue under a new owner are normalised so the figure reflects what the business really earns.

Market-based valuation compares your business with similar ones that have recently been sold, often by applying a multiple of earnings or revenue to your own figures. It answers the question a seller asks: what are buyers actually paying?

The difficulty is finding comparable sales. Private company deals are often confidential, and no two businesses share the same customers, contracts and risks. Any multiple quoted without its source, sector and date should be treated with caution, which is why this article does not give one. A valuer or broker working in your sector will have better evidence than a general rule of thumb.

Goodwill is the value of a business over and above its tangible assets, reflecting things like customer relationships, reputation and trading position. It is often the largest part of what a buyer pays for a profitable service business.

HMRC’s manual makes a point worth remembering: the value of a company is not necessarily arrived at by adding a goodwill figure to the value of its net tangible assets if that total is not supported by earnings. Goodwill has to be earned through profit. A business that does not make money rarely has much of it, whatever the owner feels it is worth.

Debt reduces what the owners’ share is worth, because what the business owes comes off the value before anything is left for shareholders. Two businesses with identical earnings can have very different equity values if one carries heavy borrowing.

Buyers and valuers therefore look at the value of the whole business and then deduct borrowings and add cash to reach the price for the shares. Be clear which figure you are being quoted, because a headline value and the amount the seller actually receives can differ by the amount of debt.

Yes. A valuation for a sale, for a tax return and for a funding application each answers a slightly different question, so the same business can legitimately have more than one value.

For capital gains tax, the Taxation of Chargeable Gains Act 1992 defines market value as the price which assets might reasonably be expected to fetch if sold in the open market. HMRC may challenge a figure it thinks is too low, and it has a specialist team for valuing shares and assets. Where a valuation affects a tax bill, such as on a gift of shares, a transfer between connected people or a share scheme, take advice from an accountant.

You can estimate a value yourself to understand where you stand, but anything that others will rely on is better prepared by a professional. A rough figure from your own accounts is a reasonable first step before a conversation with an adviser.

A business with little trading history has few earnings to work from, so income methods struggle and any figure rests heavily on forecasts and judgement. Start from a realistic cash flow forecast and keep the assumptions visible. If you are weighing a purchase, our guides to buying a business and management buyouts cover what happens once a price is agreed.

Capzy does not value businesses. We are a credit broker, not a lender, and are paid by the lender. If a valuation leads to a purchase, a buyout or a need for funding, we can introduce you to lenders that offer acquisition finance and other debt products.

You can check your funding options with a soft search that does not affect your credit score. A full application to a lender may involve a hard search, and any offer is subject to status and lender criteria. Capzy arranges debt finance, not equity or investment.