Whether you are aiming to buy or sell a retail company, you will need to secure the most competitive price to get the best value. If you are a buyer and have paid too much for a company, you’ll be negatively affected before you start trading. Where a seller undervalues their retail company, they may receive a quick sale but will also lose money.
Retailers who want to sell their company may have a rough idea of what it is worth. However, in order to attract the right buyers, your valuation should be based on your retail company’s tangible assets. Even if you are not looking to sell your retail company, being aware of its current value will assist you in making smarter financial decisions. Along with that, being aware of the value of your inventory will also help you make smarter financial decisions. Click on the link below to be taken to your very own downloadable calculator for figuring out the value for your inventory.
The valuation of a retail company is not governed by fixed rules or formulas. As a result, the process can be challenging. Overall, the value of a company is determined by what you want to sell it for and what a buyer is prepared to pay. However, there are some common valuation techniques and key figures that will provide an estimate of what your retail company is worth.
The key figures that are generally used to value a company include:
- Net income – This is your company’s income before tax.
- Leverage – The amount a potential buyer will need to borrow to buy your company.
- Margin – This figure is worked out by dividing your net income by your revenue.
- Ownership – The percentage of the business you own that will be transferred to the buyer.
- Growth in revenue – This figure is your company’s compounded annual growth
How to value a company
There are common processes that can be used when determining the value of any company. The most suitable process will depend on the type of company you own, as well as your company’s liquidity.
Here are three common ways to determine the value of a company:
The market-based valuation process values a company based on its earning potential in relation to the market demand for its goods and services. The aim of the market-based valuation process is to work out the fair market value of your company. Using this process will value your company at the going rate of a similar business in the same market.
The following are two essential steps a buyer should take when applying a market-based approach to valuation:
- Market size
The potential buyer needs to start by specifying what your company does and detailing the goods and services you provide. This review should include an assessment of your company’s goodwill. In this context, your company’s goodwill is the difference between what a buyer would pay for your company and the amount of your net assets. The potential buyer should then carry out an investigation into the actual and likely market for your goods and services. The investigation also needs to include an evaluation of your competitors. This approach will provide the approximate size and growth of your company’s market.
- Comparison to similar companies
When the potential buyer has finished the investigation and analysis of your company’s market, they will compare your company’s performance in relation to other businesses with similar goods and services in the same market.
The market-based valuation process will be suited to your company if the size of the market and your position within the market can be worked out easily. Therefore, this approach will be unsuitable for your company if there are no businesses in your market that offer similar goods or services and are of a comparable size.
The income-based valuation process entails providing an estimate of your company’s future cash flow and applying a discount to establish its value in the present day. A discount rate needs to be applied, which accounts for the level of risk someone would assume if they invested in your company. If you own a young company, you will be regarded as high risk. Therefore, you will need to provide a higher discount rate to your company’s future cash flow estimates.
The following terms must be used when applying the income-based valuation process:
Pre-tax profit – Your company’s earnings before taxes, which is a percentage of revenue or sales.
After tax profit – This is calculated by dividing your profit after taxes by the revenue you have received.
EBITDA – Your company’s earnings before interest and taxes with the addition of amortization and depreciation.
EBIT – This is your earnings before interest and tax.
The asset-based valuation process gives a dollar value on your company’s assets and liabilities.
The formula for the asset-based process is:
Assets – liabilities = company value
You need to answer the following questions when applying the asset-based valuation process:
- Who controls the asset?
- How marketable is the asset?
- What assumptions have been made in relation to the value?
- Is the company income-based or asset-based?
Selecting the appropriate assets and liabilities that will be included in the valuation can present an issue for your company. Additionally, you must decide how to make the valuation of the chosen assets and liabilities as precise as possible. Valuing liabilities are straightforward because the values are normally set. However, valuing assets can be more difficult.
When using the asset-based valuation process, you must account for tangible and intangible assets. Your balance sheet is a good place to start when using this valuation method. However, please note that your balance sheet’s valuations do not account for any added value of specialized products developed by your company.
The asset-based valuation process is best suited to companies that have a high amount of tangible assets. This is because it can be difficult to accurately evaluate intangible assets, for example, trademarks, salespeople and employees.
How to value a company based on revenue
The times revenue method is another common way to value a company.
The times revenue method uses a multiple of current revenues to calculate the maximum value of your company. The multiple used is dependent on aspects such as, the economic environment, local business and your industry. The multiple can vary from one or two times your actual revenues. Multiples can also be less than one in certain industries. An example of this method is, if your company’s revenue for the past year is $50,000, using the times revenue valuation method, your company could be valued at $100,000 (two times the revenue) or $25,000 (half times the revenue).
The times revenue method is in relation to your company’s actual revenue over a specific period of time and also a multiplier that provides a range to be used to negotiate with potential buyers.
The times revenue method aims to make a valuation of your company by assessing your streams of sales cash flows. This valuation method will be suited to your company if it is in the younger stages or is expected to experience quick growth. Where your company has a high percentage of recurring revenue and is set to experience high growth, it is likely that the valuation will be up to four times your revenue range.
Small businesses can use the following revenue valuation process, which is different to the times revenue method.
For this revenue valuation method, the business owner finds the lowest price that their business can be sold for. This price is known as the ‘floor’ and is the liquidation value of the small business’ assets. The business owner then works out the highest price (ceiling) that their business can be sold for. After the floor and the ceiling prices have been determined, the business owner can make a decision about how much their business is worth.
In general, using revenue to value your company is not considered to be a reliable method. This is because high revenues does not equate to high profits.
More processes to value a company
- Liquidation value
The liquidation value process is based on imagining that you had no choice but to sell your company’s assets at short notice, for example, in under a year. Therefore, the liquidation value is the remaining balance if you sold your company’s assets at current market prices and after you have paid your liabilities.
The capitalization valuation process is where your company uses its cash flow (or net present value of projected profits). This takes into account future earnings and divides them by a capitalization rate.
The capitalization formula is:
Net operating income/current market value = capitalization rate
You can work out the capitalization of your company using two methods:
- Single period capitalization
Single period capitalization is the easiest method to use if your company knows its growth ratios and has a steady cash flow. A disadvantage of using this process is that you have to assume that your cash flow and expenses will stay the same over a specified period of time.
2. Multiple period capitalization
Multiple period capitalization is where your company’s valuation is based on two or more periods.
- Owner benefit
The owner benefit valuation process is generally suitable for small businesses, including small retailers. This valuation process removes the requirement to estimate your company’s future performance.
Use the following formula to work out the value of your company using the owner benefit process:
Profit (pre-tax) + company owner’s salary + additional owner benefits + interest + depreciation – capital expenditures allocation = pre-multiple owner benefit
After you have worked out this figure, you need to apply a chosen multiple to calculate your company’s value. It is common for small businesses to use multiples between one and three. The size of the multiple can be affected by the level of growth in your industry, the size of your company and the length of time that you have been in business.
How to value a retail company
The methods and processes above can be used to value any company. However, here are some specific and practical steps to value your retail company:
Assess your financial statements – You should start by reviewing statements, such as profit and loss, inventory reports and budgetary statements to work out your annual gross profits. To determine your annual net earnings, subtract expenses, like labor costs, insurance, and marketing from your gross profits.
Carry out market research – You need to research your market to find out how many retailers in your locality are direct competitors. Your market research should include physically visiting your competitors’ stores and also reviewing their online presence.
Produce an asset report – To create an asset report, you need to record every tangible and intangible asset that your retail business owns. Intangible assets in your retail company could be your salespeople and customer loyalty. Tangible assets for your retail business can include inventory, cash registers, and computer hardware.
Consult brokerage firms – You can do preliminary research to get an idea of how much brokers will pay for a retail company like yours. Online brokerage websites, like BizQuest, can be used to compare values and provide you with information about a fair market price.
Consult a retail valuation expert – You should use a professional, such as an accountant, or a business valuation expert to assess your assets and financial statements. This professional can also conduct market analysis to determine the value of your retail company.
Seek advice from a business attorney – Using the services of a business attorney can assist in accurately valuing your retail company. A business attorney will use proven processes and also ask the right questions to uncover useful information that may affect your valuation.
The method you use to value your retail company will depend on your needs. If you are looking for a rough estimate of your retail company’s value, you can select only one of the methods above. However, you can choose to use more than one method if you want a more detailed valuation.
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