The Basic Mechanics Of A Business Valuation

There is a wide range of reasons why you may need to attach a value to your business.

- Gareth Watson

While a simple web search for “how to value a business” will produce plenty of methodologies, approaches, tips and “rules of thumb”, the bad news is that only some of these will be appropriate to value your business.

Understanding the basic elements to a business valuation exercise can put you in a better position to assess proposals for your business, and for potential future transactions where its value is involved.

Common elements to all valuations

Generally speaking, business valuations aim to place a fair value on a business. Just like there are many different types of businesses, there are many different valuations methodologies and approaches. However, they all share some common elements and underlying principles.

Cash is king. A valuable business is one that demonstrates healthy, reliable cash generative ability. This is often referred to as Free Cash Flow (“FCF”) and is broadly a measure of the cash that is available to investors in the business. FCF is itself quite a broad topic, but the common thread is consistency: businesses that generate consistent cash flows tend to attract higher valuations than those that don’t.

The past does inform the future…to some extent.