How to Value a Business
This is probably the most difficult aspect for you to consider. Obviously, the vendor will want as high a price as possible while you will want to pay as little as you can. There will probably be a number of components making up the final price. The first thing that you will need to do is establish exactly what those components will be. To do that you will require up-to-date audited accounts. Let us take a theoretical example.
Balance Sheet of XYZ Engineering Ltd
Fixed Assets
Land and buildings £1 00,000
Plant and machinery £30,000
Tools and equipment £1 5,000
Motor vehicles £30,000
£175,000
Current Assets
Trade debtors £ 25,000
Raw materials £ 10,000
Finished goods £ 20,000
Cash at bank £5,000
£60,000
Total Assets £235,000
Current Liabilities
Trade creditors £ 15,000
Other creditors £10,000
Hire purchase £ 5,000
Bank loan £5,000
£35,000
Long-Term Liabilities
Hire purchase £ 15,000
Bank loan £35,000
£50,000
Net Assets £150,000
Represented by:
Share Capital £ 50,000
Profit and Loss Account £100,000
£150,000
On the face of it, this business is worth £150,000 - or is it? Remember these figures are all 'book' valuations. Further examination will be required to confirm the 'book' valuations as realistic. Let us break down the individual components and examine the reasons for possible distortion.
Fired Assets
The fixed assets will more than likely have been valued at the original cost price less any depreciation that has been allocated. Their true value may, however, be substantially different. For example:
- Land and buildings - If the property was purchased some time ago it may have increased in value. By the same token, if it was purchased recently and property prices have since fallen, the true value may be less. The only way to establish the correct price is to have the property valued by a professional.
- Plant and machinery - The 'book' value will bear no relation to the 'true' value because resale prices are likely to be substantially less. Within the existing business, however, their value is pure conjecture. You will need to consider the condition of the items involved and whether the depreciation is realistic.
- Tools and equipment - The valuation of small items such as these will prove to be extremely difficult. It could actually be virtually impossible to identify all of the individual items involved.
- Motor vehicles - Just as with the plant and machinery, the 'true' valuation is likely to differ from the 'book' valuation. With a small number of vehicles, as in this case, it should be relatively simple to gain a valuation from a motoring organisation. With a large number of vehicles the situation is more complicated. It is probable that a number of the vehicles involved will be 'on the road' and away from the business premises.
Current Assets
With all of these assets being 'liquid', the actual figures involved are likely to be substantially different. Unlike the fixed assets, which remain relatively unchanged over short periods, the current assets will change on a daily basis. For this reason, they cannot be accurately valued until the business actually changes hands.
Liabilities
The current liabilities and the long-term liabilities can be considered together for the reason that in this instance, the hire purchase and bank loan have been split purely for accounting purposes. On any given day both of these will show the same individual amount in the current liabilities section representing the amount that is due within the next 12 months.
Considering any 'Goodwill'
It is likely that even if no amount is included within the balance sheet you will be faced with a request for a suitable sum to be paid for 'goodwill'. Thus is a difficult figure to establish because it is not represented by any tangible assets. It relates purely to an intangible asset that the vendor now wishes to try to value. It might include items such as:
- strong commercial reputation
- established brand names, trademarks, or copyrights
- future products that are reaching the end of their research and development.
This is an area where extreme care is required. The existing owner will argue that they have built up the business to what it is now and they deserve some benefit. Unless there is a large retained sum in the profit and loss account you must remember, however, that they have already withdrawn their reward from operating the business.
