Book value
The book value of a business is determined by looking at all its assets, including cash, equipment, furniture, supplies, and so forth, and then multiplying that total by an assigned price. The average person usually assigns a lower number to determine this price, which can be confusing.
Usually one will use the going-rate market value for each asset, but if there is no clear market value, they may assign a depreciated or written down value instead. This includes depreciation tables that calculate how much it costs to run down an item such as cost of fuel to operate machinery or what it would cost to replace something like carpeting or upholstery.
By using these numbers less aggressively, you get a lower final price tag for the business. People do not agree about whether this is a good thing or bad, but most experts agree that this method does not accurately represent the true value of a business.
It also assumes that the owners are selling the company, someone who might not be considering buying the firm. Sometimes sellers will include the books as part of the sale, but even then, people disagree over what should be included in those books.
Running a business means keeping tabs on many things, and having different interpretations of what should be counted as an expense makes calculating book value difficult.
Market value
The most common business valuation method for determining is what’s known as the market approach. This means using current sales of similar businesses to determine how much an asset such as land, equipment or inventory should be valued.
A couple notes about this approach: first, you have to know if the sale was done directly with the seller or through an intermediary like a broker. If it was done indirectly, then you will need to find out who owned the company at that time and use those numbers in your calculation.
Second, make sure to compare apples to apples. You can’t just look at the price per square foot because some properties are located close together while others are not. You want to make sure you’re comparing similarly sized properties and buildings.
Lastly, remember that markets often fluctuate so your calculations may slightly differ from what someone else has determined.
Liquidation value
The liquidation or net asset value (NAV) of a business is calculated by taking all its assets and dividing them into what they are worth, then subtracting any liabilities. This is typically done at time of sale because it gives you an accurate picture of how much money your company is worth if everything was completely erased.
The liquidation NAV can be thought of as the “true” market price of a company. It is usually lower than the book value due to costs for selling the firm (legal fees, broker fees, etc.).
Liquidation values are often used when evaluating companies in the midst of being sold so that buyers know what they are paying for. For example, let’s say Company X has been announced as being bought out within the next six months. A buyer could use a liquidation NAV to determine the true cost of owning a stake in the company. They would likely factor in the cost of buying out the current shareholders in the process!
Asset Value
The most common type of business valuation is referred to as asset value. This is typically determined by looking at the market value of all of a company’s assets, including land, buildings, equipment, financial resources, etc.
The net asset value (NAV) or equity value is then calculated by subtracting total debt from the overall asset value.
The average cost method is used to calculate the NAV for this reason. With the average cost method, we divide the total amount of debts owned by the company by the number of shares outstanding to determine the per share debt ratio.
This ratio is multiplied by the price per share to get an estimate of what the stock would be worth if it were sold as a whole. Then, the difference between these two numbers is the net shareholder’s equity or shareholder’s investment in the company!
Debt to Equity
Debt to equity is one of the most fundamental business valuation methods. This method compares the value of your company with its net worth, which is determined by adding all current liabilities (debts) such as loans or bills you have run out and assets such as furniture or cars. The difference between these two numbers equals the net worth of the company.
By this test, the greater the ratio of debt to equity, the less financially sound the company is. A high debt to equity ratio means that companies must spend a large amount of money to purchase the company, making it more expensive for investors.
When calculating debt to equity, you should not include any long-term debts like credit cards in the equation. These types of debts will be included in the asset side of the calculation since they do not completely disappear when the company goes bankrupt.
Return on Investment
The return on investment (ROI) is one of the most common business valuation methods. This method looks at how much money your company makes compared to what it costs to run the business. If the ROI is high, then you should keep investing in the business and increase the size of the organization or start new ventures with this firm’s CEO as chief financial officer!
The numerator of the equation is determined by taking the net profit of the business and dividing it by the cost of running the business. The denominator is the total time in operation multiplied by the average cost per year.
Net income is usually reported as either a profit or loss. A net loss means that the business had lower than expected earnings, whereas a net gain indicates that the business made more money than anticipated.
These calculations are typically done for a limited amount of time, such as a year. When calculating the ROI over longer periods of times, like five years, you must also account for inflation.
