Fortunately, a business valuation expert can help you arrive at an appropriate value for your company. Here’s a primer on the methods used to value many businesses.

Valuations based on assets

These valuations reflect a tally of the business’s tangible assets, including inventories, plant and equipment, and so forth, as well as intangible assets, such as patents, trademarks and customer lists. Some of these assets can be sold to generate cash if the company fails to perform as expected.

However, this type of valuation isn’t always a reliable way to estimate a business’s future earnings potential, because company-owned assets don’t automatically reveal the money it likely will generate. Instead, asset-based valuations often are used for businesses headed for liquidation.

Valuations based on comparable transactions

Assessing the prices of similar businesses makes intuitive sense: Similar companies should command similar values. However, it can be difficult to find truly comparable businesses. Even two companies that appear similar to outsiders may vary widely in their performance because of differences in, for instance, management expertise or long-term contracts with major customers.

Valuations based on a multiple of earnings

With this method, a business’s value is based on some multiple of its earnings. Many valuation experts tend to place more emphasis on this method, though they’ll factor the other approaches into their analyses as well.

A starting point is to identify a representative earnings number. Many business owners use EBITDA — earnings before interest, taxes, depreciation and amortization — or a similar formula. To calculate the earnings number, they may add back the salary and other benefits currently going to the owner.

Once the earnings number is determined, both buyer and seller must agree on the years to include. Because potential buyers often are most concerned with the future, they may want to see earnings projected at least for a year, and potentially several years.

Although these numbers will, of course, be projections, they need to logically tie back to current performance. Assumptions used to arrive at the projections need to be reasonable. Projections showing a dramatic increase from current sales should be supported with some rationale, such as a new, ongoing and large order or a continuing long-term contract with a significant customer.

The appropriate multiplier can depend on many factors, such as the:

For instance, businesses with real estate holdings that are easily marketable may command higher prices, as the properties could be sold even if the company doesn’t perform as expected. Conversely, multipliers may decline when the supply of a certain type of business is high — it’s supply and demand in action. A business valuation expert can provide much-needed insight here.

In the end, of course, a business is worth what a buyer at arm’s length is willing and able to pay for it. The approaches outlined here can act as a starting point when determining value. But, often, the valuation process will incorporate multiple approaches — though one may be given more weight than others.

The bottom line

Business owners can set the groundwork for an effective valuation by keeping solid financial records, operating their businesses as best they can, and gaining an understanding of the various methods involved.

Above all, engage a qualified business valuation expert. He or she can bring a solid understanding of the market. But, just as important, a valuation professional will be a disinterested party who can assess your business as most potential buyers will — without emotion overtaking judgment. As a result, he or she can reach a credible, defendable value estimate.

Sidebar: 5 ways to boost your business’s value

There are a variety of ways to increase your company’s value in the eyes of potential buyers. Here are five to consider:

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