How can we VALUING A BUSINESS before we invest into it??

 

Business valuation is the assessment of economic value for that business.

It is important to be able to create a range of values for a  business; from high to low.  

I was involve in process of buying a business in my hometown which is in remote village.I has been called to help my relatives to asses the worth of the business. 

Liquidation Value: will give the lowest value

Cash                                       100%

Accounts Receivable            80-90%

New Inventory                        50-70%

Used Inventory                     10-40%

Used Equipment                 60-80% (Auction Value)

Land & Building                      60-80% (Appraised Value)

If you buy the assets, then you may have no responsibility for liabilities.  The sale will be governed by the Bulk Sale Act.  If you buy the stock, then you will become responsible for the liabilities.

Market Price:  This term is used in two ways:

First, the price a business broker might use.

Second, the price of the business if it was traded in the market.  You derive that price by comparing it to similar, publicly traded companies.

Book Value:  The value of the company is determined by Assets minus Liabilities.

If assets have been significantly depreciated and yet have maintained a market value, then the price will be understated.  For example, if you bought a corner of XYZ area in 1951 and have depreciated the land to $1, then it will be “undervalued” on the balance sheet.  The market value of the land will be much greater than the book value.

Rule of Thumb:  Research has shown that small businesses sell for 4 to 6 times after tax earnings.  Basically, you will “get your investment back” in 4 to 6 years.

Capitalize Future Earnings:

1.  Project future earnings for the next five years.

2.  Average those earnings.

3.  Capitalize the earnings using a capitalization rate that reflects both risk and potential return.

Example:  The average earnings of ABC company are $100,000.  Your banker and accountant have analyzed the risk involved with the company and have suggested you capitalize it at 20%.  What is the value of the firm?

Valuing Goodwill 

Goodwill is the ability to make above average profits.  If the firm you are purchasing is not making a return on assets (ROA) above the average in the industry then you can argue that there is no goodwill.