How to value a business: methods you can use

Running your own business means embarking on several processes, from figuring out how to get clients to devising pricing strategies for your products and services. A vital part of this mix is understanding how to value your business.

Getting this right doesn’t just let you know how much your enterprise is worth. It can also have a big impact on the decisions you make and the results you get, especially when you’re:

• Contemplating a sale

• Plotting your next big move

• Gearing up to attract fresh investment

Whether you’re looking into how to value a startup business or exploring how to value a business quickly, this guide will help. We’ll cover tools and strategies you can use to pinpoint the value of a business accurately, ensuring you’re ready for whatever scenario comes your way.

How to value a small business

There isn’t an off-the-shelf solution when it comes to how to value a business. In fact, there are several approaches, each suited to different aspects of business operations and financial health.

The right valuation method depends on elements like how big your business is, how long you’ve been up and running, and crucially, the reason for your valuation. Planning to sell, seeking investment, or refining your growth plans each dictate a different approach.

It helps to consider what makes your business distinct. Whether you’re selling handmade knits online, running a bustling café in a small town, or developing new small business cyber security tools as a tech startup, your location and what you do plays a big role in shaping the valuation approach you should take.

For example, a traditional family bakery in a quiet village won’t be valued the same as a fast-growing IT firm in a big city. Ultimately, the best way to value your business depends on your specific circumstances and goals.

Business valuation methods

Some approaches to how to value a small business don't require extensive financial data or complex calculations, making them ideal for smaller enterprises, startups, and those seeking a quick assessment.

Other methods provide a deeper dive into a company’s financials and can sometimes be a bit better suited to larger businesses or publicly traded companies. However, more complex business valuation models can still be valuable for smaller businesses preparing for significant growth or a public offering.

Using a mix of valuation methods – considering hard data like sales figures and assets, alongside softer, more subjective factors such as a business’s reputation and competition – often provides the most accurate picture.

In this section, we’ll run through these common ways to value a business:

• Entry valuation

• Times revenue

• Discounted cash flow

• Asset valuation

• Comparable analysis

• Precedent transaction

• Industry best practices

• Price to earnings ratio 

Entry valuation

The entry valuation method estimates the value of your business by calculating the cost of starting a similar venture from scratch today. 

It considers everything you need to get up and running. For a clothes shop, for example, you’d account for costs like leasing space, filling the racks, installing a point-of-sale system like POS Pro, and promoting your business.

Key costs can also include hiring employees and money you invest in creating a positive working environment, but it’s also important to think about potential cost savings. Entry valuations factor in these savings – that is, areas where you could potentially lower costs should a business start over.

For example, could a more affordable location still attract plenty of foot traffic? Or are there more economical ways to advertise a business? These savings are knocked off total startup costs to determine the entry valuation cost:

Entry valuation cost = total startup costs – potential savings

This method is useful if you’re thinking about setting up a limited company and contemplating initial costs of starting a business, or if you’re planning to expand a business, such as with a new location. However, it primarily focuses on startup expenses and doesn’t take future profitability or growth into account.

Times revenue method

How to value a business based on turnover is a common question posed by entrepreneurs. The answer comes courtesy of the times revenue method.

This straightforward approach multiplies your revenue by an industry-specific multiplier. It’s suitable for new business entities which have clear revenue streams but without a long-running earnings history to work from. The multiplier used typically ranges from 0.5 to 2, depending on how fast the industry is expected to grow. For slower-growing sectors like manufacturing, lower multipliers are common, while fast-growing fields such as technology might use higher ones.

Consider a digital marketing agency. With the times revenue method, you multiply its annual turnover by a multiplier that suits its market position and growth potential. 

So, if the agency turns over £100,000 a year and the multiplier for the sector is 1.5, the valuation would be £150,000.

Times revenue valuation = annual revenue x industry multiplier

The times revenue method offers a quick check on value but doesn’t factor in operating costs or profitability. So, it might not show the full financial picture. It’s ideal for initial assessments but more detailed analysis is advisable for serious investments or long-term planning decisions.

Discounted cash flow (DCF)

The discounted cash flow method values businesses based on the present worth of their future cash flows. This makes it ideal for enterprises with stable, predictable revenue streams like, say, a well-established B&B.

To apply DCF, start by calculating the net cash flows from operations. For a B&B, this could include income from room rentals, events, and other services, after deducting expenses like wages, maintenance, and supplies.

Then, adjust these future cash flows to their present value using a discount rate that reflects the benefits of receiving money sooner rather than later along with the risks involved, like economic downturns impacting bookings or unexpected maintenance costs.

For example, if a B&B expects net cash flows of £120,000 annually for the next ten years, applying a 10% discount rate would give a current valuation of about £737,348.

The DCF method offers in-depth financial analysis, and is useful for decisions related to buying, investing in, or funding a business. However, the calculations can be complex and are best managed with accounting tools for small businesses or by professionals.

Keep in mind that DCF heavily relies on accurate cash flow forecasts and using the correct discount rate. Even small errors can throw off valuations, so it's important to use realistic numbers and sometimes get advice from experts to make sure everything checks out.

Asset valuation

Asset valuation determines a business’s worth based on the current market value of its assets. It’s ideal for businesses with a lot of physical assets, like a furniture manufacturing company with machines, tools, and stock, but also looks at the things you can’t touch, like a strong brand or unique designs.

Following this method involves summing up everything a business owns, from equipment to trademarks, and subtracting what the business owes, such as debts and outstanding credit. This gives you the net book value – the total value of all assets right now.

Net book value = current assets – current liabilities

This approach provides a solid snapshot of both tangible and intangible assets. However, its accuracy depends on up-to-date records. Monitoring changes like wear and tear on equipment and increases in property value helps keep valuations on point.

It’s important to note that asset valuation often returns the lowest valuation for a business compared to other methods. That’s because it might not fully account for goodwill – factors like a strong market position or particularly loyal customers, which can bump up what a potential buyer would be willing to pay.

If you’re thinking about how to value a business for sale, it’s best to consider asset valuation in the same way as the times revenue method – as a starting point. 

To fully grasp your business’s worth, exploring other valuation methods is a must, especially for service businesses with minimal physical assets.

Comparable analysis

Comparable analysis values a business by comparing it to similar businesses in the industry. It’s much like setting the sale price of your car by comparing it to similar vehicles currently on the market.

For a food and drink business like a cocktail bar, this would mean checking out the sale prices and financial metrics of other local bars or restaurants, especially those with a similar size and customer base. The goal is to get a sense of what your business could be worth based on the going rates for comparable places.

To improve the accuracy of your valuation, you can also look at publicly traded businesses similar to yours. It’s often easier to access detailed metrics for these companies, which can offer useful benchmarks.

However, public companies often carry higher valuations due to their market visibility and liquidity. So, if you do look at these businesses, you might need to adjust your valuation downward by as much as 50%, or perhaps even more if your business is very small. This adjustment is really important when figuring out how to value a private business accurately.

These comparisons, plus your business’s unique features such as using modern tech like self-service kiosks, help give a clearer view of your business’s worth. Features like these make your business stand out and could make it more attractive to buyers by improving customer service and making operations smoother.

By looking at similar businesses and considering what makes yours special, you can figure out a realistic price for your business in today's market.

Precedent transaction method

As with comparable analysis, this method relies on looking at other businesses in your industry, but this time you’re focusing on how much they have been acquired for.

This approach generally offers a solid, up-to-date valuation based on the latest market transactions. It’s particularly valuable if you’re thinking about how to value a business to sell, as it accounts for the premium buyers will often pay for a business’s future potential.

However, this method requires frequent updates as transaction data can quickly become outdated. It's best for markets where sales are common, helping you stay current with pricing trends.

To prepare for a sale, it’s wise to understand the legal requirements for starting a small business and have effective expansion strategies. This ensures your business will have always been compliant with the rules, so nothing untoward comes to light during the sales process.

Showing that your customer acquisition efforts are gaining traction can also highlight your business’s growth potential to prospective buyers.

Industry best-practice

The industry best-practice method values businesses based on common industry-specific metrics, and works well in sectors where there’s consistency across operations and performance, like membership renewal rates at a gym.

A boutique hotel offers another example. Valuation metrics in hospitality – such as average daily rate (ADR), occupancy rates, and revenue per available room (RevPAR) – are standardised and widely accepted.

These metrics serve as a “rule of thumb”, helping you understand how your business stacks up against other similar establishments. This helps you with valuing a business and also assists with day-to-day decisions like how to price a service. 

Industry best-practice provides a current snapshot of your business’s standing, but similar to precedent transaction valuations, valuations require frequent updates as market conditions can change fast. Also, valuations for private businesses may need adjustments if compared to public ones.

Price to earnings ratio (P/E)

The price to earnings ratio is a key metric used to value businesses, especially larger or publicly traded companies. It shows how a company's current share price compares to its earnings per share.

Take a tech startup gearing up for an initial public offering (IPO). By applying the P/E ratio, the startup can gauge how the market values its earnings against other tech companies.

The P/E ratio is calculated by dividing the market value per share by the earnings per share (EPS). This ratio tells investors what they might expect in earnings from their investment, which is essential for IPO preparations.

P/E ratio = market value per share / earnings per share

A high P/E ratio could mean the market expects big growth in the future. A low P/E ratio might suggest the business is undervalued or expected to grow slowly.

It’s an effective approach for industries where earnings and growth prospects are clear. For entrepreneurs thinking about how to scale a business or go public, the P/E ratio helps measure investor interest and market value.

However, this method assumes that past earnings indicate future performance, which may not always be the case. Companies should have solid financial plans and growth strategies to support P/E ratio claims.

If you’re not yet ready to go public, understanding the P/E ratio can still provide insights into how businesses in your sector are valued, guiding financial plans and decisions around your marketing strategy for small business. 

How to increase the value of your business

Once you know how much your business is worth, it might be time to look at how you can boost its value. 

This goes beyond thinking about how to make extra money; it’s about long-term strategies for making your business more attractive to buyers or investors by showing you're on top of your financial game.

Let’s look at some key ways to bump up your business’s value. 

Strengthen your financial health

Getting a better valuation starts with keeping small business finances in good shape. Here’s some things you can do to manage your money better:

• Regular cash flow checks – Keeping an eye on your cash flow statement can allow you to catch and fix problems quickly. 

• Better cash handling – Improving cash flow can be a good way to boost your business’s value. Achieving a better operating cash flow could mean agreeing better terms with suppliers or finding quick ways to sell stock, like flash sales.

• Clear financial records – Keep on top of bookkeeping for small businesses with dependable accounting software. This makes decision-making easier and helps attract potential investors.

• Cut costs – Regularly assess small business expenses to find savings opportunities. Streamlining processes like invoicing can cut costs significantly. Reducing overheads, such as energy bills or the cost of how to do a payroll, also boosts your profitability.

• Manage taxes –  Stay proactive with your taxes to avoid surprises. Working with a financial adviser can help you find deductions and avoid penalties, keeping your cash flow steady.

Mix up your revenue streams

Diversifying your revenue options by exploring creative ways to make money can help make your business stronger and more valuable. By adding new products or services, you're not just sticking to one way of making money, which can really help if market trends shift.

You might consider low cost business ideas or explore side hustle ideas that fit well with what you're already doing. For instance, if you have a physical shop, you could think about selling online too.

An online store is a great way to reach more customers, not just those who walk past your door but from all over the country, or even the world. The bottom line is, good online business ideas could seriously broaden your market and boost your sales.

Improve customer experience

Making your customers happy encourages return business and helps increase your business's value. Here are some good moves for elevating customer satisfaction.

• Train your team – One of the benefits of training employees well is that they’ll be more likely to provide the knowledgeable, attentive service that helps turn casual customers into loyal fans. You might want to train staff members in cross-selling products and services, and offering customer add-ons like gift cards.

• Use email marketing effectively – Regular updates and personalised messages keep your business on your customers’ minds. This approach makes email marketing for small businesses a powerful tool for boosting customer retention by keeping them informed and excited about what’s new.

• Get social – Use platforms like Facebook and Instagram to share behind-the-scenes content, offer special deals, or just connect with customers through comments and messages. Mastering how to use social media for small business success can help you reach more people and create a community around your brand, attracting both new and returning customers.

• Gather feedback – Listen to what your customers have to say by collecting feedback through online surveys, comment cards, or direct conversations. Using their input to improve your services or products shows you care, which can greatly increase customer loyalty and satisfaction.

Conduct regular market and competitor analysis

Keeping tabs on the market and your competitors is essential for staying ahead. Here’s how you can better understand your position and plan your next moves.

• Stay up to date on your sector – Follow industry news and reports to catch the latest market trends. This helps you adapt and innovate, ensuring your business stays relevant and valuable.

• Analyse competitors – Watch your rivals’ moves, from product launches to marketing tactics. Learn how to do a competitor analysis properly, using tools that track their activities.

• Perform a SWOT analysis for small business – This is a time-honoured technique for laying out internal strengths and weaknesses, and external opportunities and threats, highlighting areas where you excel and where there’s room for improvement.

• Network – Small business networking opportunities like industry conferences, online forums, and local events can unlock valuable insights that might be applicable to your business. It’s also a great way to stay connected and informed about your industry and potential collaborations.

• Track performance – Use analytics to compare your business’s performance with that of competitors. This helps in assessing your marketing efforts and showcases your business's growth potential to investors or potential buyers.

Prepare for future opportunities

Being ready for new chances can really boost your business’s value. Here’s how to be prepared.

• Update your plans – Keeping your business strategies and intentions current helps you stay on top of market changes and plan for the future. Learn how to write a business plan that incorporates possible expansions or new opportunities.

• Stay alert – Look out for potential partnerships or new markets that fit your goals. Acting fast on these business opportunities can help your enterprise to grow and become more profitable.

• Keep records in order – Having clear and organised records makes your business look more trustworthy and ready for any transactions with potential partners or buyers.

• Know the legal stuff – Understanding the legal requirements for your industry is vital, especially if you're thinking about growing or selling. It ensures everything you do is above board.

Optimise operations

Improving your operations management can cut costs and help you deliver better service. Take a close look at how things are done in your business to spot inefficiencies or possible slow points. Then, consider integrating technology solutions to improve those areas.

For instance, a café that expands its seating to an outdoor area might notice longer queue times due to an increase in customers. Implementing portable payment solutions like a card machine will allow staff to process payments directly at the table, enhancing customer experience by minimising wait times.

This not only boosts service but also feeds into building a positive workplace culture and your employee retention efforts by simplifying tasks. These efficiencies can reduce costs and create more value within your business.

Focus on long-term goals

When considering how to run a business effectively, it's important to keep your eye on the big picture. Your day-to-day activities should always help you reach your bigger goals, whether that's growing your company or getting it ready for a sale.

Start by setting clear long-term goals. What do you want to achieve? Are you hoping to grab more market share, revamp your product lineup, or even get your business ready for a public offering? With these goals in mind, you can shape your strategies to support these objectives.

Even if you're happy with the size of your business now, solid financial planning and forecasting are still valuable. Good financial analysis helps you see where you can improve and grow. Setting clear goals ensures your decisions support your long-term plans, which helps increase your business's value no matter what the future holds.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.