Every entrepreneur should know what their business is worth and how to determine what an organization they are looking to potentially buy is worth. Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to effect a sale of a business. This course is designed to provide you with the basic means of determining business value.
You can start determining the value of an organization by looking at their assets. What does the business own? What equipment? What inventory? After all, you’d have to buy all the same stuff if you were starting that business from scratch, so the business is worth at least the replacement cost of those items. Warren Buffett uses what’s called a discounted cash-flow analysis. He looks at how much cash the business generates each year, projects it into the future and then calculates the worth of that cash flow stream “discounted” using the long-term Treasury bill interest rate.
There are a lot of equations and methodologies typically used to value a business. There’s no “right” way, though you could probably come up with several wrong ones. Ultimately, the business is worth whatever you think it’s worth, based on the criteria you set forth and the metrics you determine matter the most. Check out the video below on how Warren Buffet calculates the intrinsic value of a business.
Most valuation approaches treat businesses as a stream of cash. They value a business by trying to come up with a value for that stream of cash, which is usually defined as it’s revenue. Revenue is the crudest approximation of a business’s net worth. For example, if a business sells $100,000,000 in products per year, you can think of it as a $100,000,000 revenue stream, however, businesses are often valued at a multiple of their gross revenue. The multiple depends on the industry and is usually expressed in terms of “two times sales” or “one times sales.”
Any seasoned entrepreneur will tell that revenue doesn’t equal profit. For example, how would you value a business that had $4 billion in gross revenue annually, but required a cash investment of $380 million per year just to keep it afloat? To help you make sense of it all, the following valuation idiosyncrasies will be discussed in our course:
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