Business Valuation Methods
There are basically three methods of valuation: • Asset Method
• Income Method (Net Cash Flow) • Market Method Using a Multiple
Asset Method - In general, small/medium businesses (under £50M) are valued on their ability to produce profit/cash flow and therefore we would use one of the 2 methods below and not this method. The asset method is generally used where the assets are not generating a profit that is greater than their value. So for example, a machine shop is running break even or at a loss and it is sometimes better just to sell the machines and inventory rather than trying to sell the going concern with goodwill. Sometimes this can be morphed into selling a customer list or recurring contracts but inevitably we revert to one of the methods below as the value is determined by the profitability. It is important to note that you choose only one method and do not add them together. So if you use the Market Method below you do not add the fixed assets on top of it. The reason is that the assets are needed to produce a profit. So, for example, you would buy a fish and chip shop for a certain ratio of the profit but you would expect the fish fryer, chairs, tables, refrigerators, etc that are used to run the shop to come with it and not suddenly be added as extras. Income or Net Cash Flow (NCF) Method - This is probably the most accurate scientific way to value a business as you are taking the profit after tax cash and analysing that against a rate of return. This is very similar to how you would analyse a stock purchase on the public markets.
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