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hey guys crystal here welcome back to the channel today we're talking about business valuation let's dive in [Music] business valuation is the process of determining the economic value of your business today there are four methods of valuation i'll be going over today and that is book value earnings multiplier market value and discounted cash flow now valuing your business is not a black and white exercise as you'll see there's a lot of gray area think of it like this if you go to walmart and look at their tvs you'll see a wide variety right and for the most part all of those tvs will have different prices 4.99 6.99 8.99 etc obviously the brand and size of the tv will help determine its price but why don't companies sell their tvs for 5 000 or even 10 000 the reason is because no one would be willing to pay that price for it and therefore it is not valued at that price a large part of business valuation is determining what a buyer or investor would actually pay for your business chances are if you are just starting out and struggling to get sales and decided to sell your business a year from now you likely won't have any buyers if your sales price is 1 million dollars unless there is some data to support that valuation so the very first step in determining the value of your business is determining which method to use the first that i'm going to discuss is the book value method but before i do please give this video a thumbs up and subscribe to our channel as a cpa and co-founder of life accounting i can tell you that we are an accounting firm dedicated to helping small businesses grow through effective bookkeeping and tax and all of our videos help you do just that sound good all right book value method the book value method is derived by subtracting the total liabilities of a company from its total assets the book value approach may be particularly useful if your business has low profits but valuable assets on file assets are the resources in your business that help you earn sales so things like inventory or cash for example if you have assets on your books valuing a hundred thousand dollars and liabilities or debt of twenty five thousand dollars the value of your business would be seventy five thousand dollars under the book value method if your liabilities are higher than your assets then you would have a negative valuation and essentially your business would be considered worthless until you either pay off your debt or increase your assets the drawback to the book value method is that it does not consider a business's future earnings potential after all a lot of businesses don't have a lot of assets but still earn high revenue and even a business with high value assets could have more to offer than just the assets that they have the book value method those simple may not paint the entire picture of your business's worth the second method i'm going to discuss is the earnings multiplier the earnings multiplier method is based on the idea that a business's value lies in its ability to produce wealth in the future the earnings or income of a business are used to value a business in this method but you can look at earnings in different ways depending on what you include should you include taxes or do you include non-sales income like interest income in most cases ebit or earnings before interest and taxes is the measure used as earnings so taking your total revenue a minus cost of goods sold and operating expenses would give you your earnings before interest and taxes to value your business using the earnings multiplier approach you would need to evaluate your ebit over a period of time like over the past year you would then apply a multiplier the multiplier is usually a number between 2 and 7 and it gets multiplied by your ebit so if your earnings before interest and taxes or ebit or three hundred thousand dollars and your multiplier is three you could reasonably value your business at nine hundred thousand dollars or three hundred thousand times three a large part of this method is figuring out what multiplier to use the most accurate way to determine what multiplier to use is to work with a business appraiser they take into account a number of different factors to determine your multiplier such as business size industry market trends and business brand you could also google multipliers by industry to see the most current information on multipliers for your particular industry the third method i'm going to talk about is the market value method the market value method determines the value of a business based on the selling price of similar businesses regardless of the type of business being valued the market value method studies most recent sales of similar businesses making adjustments for the differences between them for example when valuing a retail store adjustments might be made for factors such as the number of inventory on hand foot traffic and location so for example if other retail stores have recently sold for 750 thousand dollars in your area it is likely that with all else being equal your retail store is valued somewhere near that number there are limitations with the market value method such as you may not be able to find comparable sales if the sales data is in recent it may not reflect the current market value or this method only works for businesses that can access sufficient market data on their competitors the fourth and final method i'll discuss is the discounted cash flow method this is a valuation method used to estimate the value of a business based on its expected future cash flows discounted cash flow method or dcf method attempts to figure out the value of an investment today based on projections of how much money it will generate in the future the purpose of dcf analysis is to estimate the money an investor would receive from an investment or business adjusted for the time value of money the time value of money assumes that a dollar today is worth more than a dollar tomorrow because it can be invested today and earn interest think about it like this if someone offered you one million dollars right now or one million dollars five years from now which one would you choose one million dollars today who knows what will happen in five years so you would probably take the money today do you see how money today is worth more than money tomorrow so going back to the dcf method in order to conduct a dcf analysis an investor must make estimates or projections about future cash flows and determine an appropriate discount rate the discount rate is what determines what one dollar in the future is worth today and as we just discussed a dollar today is worth more than a dollar tomorrow or vice versa one dollar tomorrow is worth less than a dollar today so if the projected cash flows of your business is one hundred thousand dollars under dcf a discount rate would need to be applied to figure out the value of that one hundred thousand dollars today and therefore the valuation of your business today the discount rate is a company's weighted average cost of capital or wacc wacc is a complex formula as you can tell too complex for the purposes of this video though there are online calculators to help you determine your wacc once you have your discount rate or wacc you would apply it to your company's cash flow projections and it will give you the value of your business today some advantages of the dcf method are it doesn't require competitor or market research and you can incorporate your assumptions and expectations about the future of your company into a dcf calculation some disadvantages of the dcf method are you use assumptions about your future growth and cash flow it's tempting to make them overly optimistic changing your assumptions can create radically different future cash flows and lastly calculating dcf is a complex approach now you know the different business valuation methods i hope i didn't confuse you too much ultimately i would recommend you hiring a professional to help you value your business as a business owner it's easy to overvalue your business and having someone else do it would create a more objective valuation there you have it i hope you enjoyed this video if you did please give it a thumbs up if you haven't already if you have any questions please comment them down below and i'll respond to them directly also subscribe to our channel if you haven't already and be on the lookout for more videos to help you with your accounting and tax needs see you in the next video