What is my business worth? For many an entrepreneur, it is guesswork. For many business owners, a business valuation only comes up for discussion "when it's really necessary," such as when selling the business or a participation of family members or employees.
But a regular valuation also offers a lot of insight into the current state of a business. Rarely is maximum enterprise value named as an explicit goal, when in fact it is the most important aspiration an entrepreneur can have.
Valuation methods
In practice, various methodologies are used to value a business, with the outcome always coming from a certain combination between return and risk. For example, by multiplying historical or future returns(EBITDA or net profit) by a certain factor/multiple that reflects the risk profile of the company.
The Discounted Cash Flow method or related variants such as the Adjusted Present Value method are considered by science to be the purest methods. Here, future cash flows (returns) are discounted at a cost of capital, based on the company's risk profile (risk).
Business valuation is all-embracing
An increase in the enterprise value can be brought about by an increase in the expected return or a lower risk profile or a combination of both. A regular valuation based on the Discounted Cash Flow method gives the entrepreneur insight into the development of the expected future cash flow (return) and the development of the risk profile. Moreover, a valuation identifies the value drivers of a company, which can be translated into concrete goals and targets.
Some value drivers are obvious, such as adding revenue to increase returns. These are therefore easy to translate into concrete goals such as sales targets. However, a valuation also provides insight into value drivers that are less on the surface. Some examples:
- Reducing dependence on owners (lowering risk profile);
- Tighter working capital management (increase cash flow);
- Better spread in revenue between customers (lowering risk profile);
- Diversification of current activities (lowering risk profile).
Improvement on these factors can then be concretized by setting (long-term) goals and targets. For example, as follows:
- Three years from now, the day-to-day management on the shop floor will no longer be in the hands of the current owners;
- If a client has not paid within the payment period, we send a reminder within two business days;
- In five years, the largest customer will still be responsible for up to 10% of total revenue;
- Developing a new product or additional service.
Focusing on such factors has the corollary of value creation and continuity. Goals that entrepreneurs often mention. In this way, a valuation is an excellent measuring tool for the current state of the company. Moreover, a regular valuation can serve as a management tool, making the development of value drivers concrete in a report.
