Must-Knows of Business Valuations
There are ‘rules of thumb’ about business valuation in Singapore and Malaysia that small business owners would follow - almost blindly. But these ‘rules’ are not a blueprint for business valuation; they serve as general guidelines.
1. The Multiple Of Turnover Does Not Always Equate To A Business’ Worth
The belief: take the turnover and multiply it with a particular number, and that is the ‘real’ or approximate business value.
In reality, there is no logic to this belief; a buyer who used this method to work out a business value would quickly go bust.
Why? Because it is very easy to add millions of dollars of ‘value’: sell an item and buy it back at the same price, and then repeat the process until the turnover increases to the desired level.
Very rarely would the turnover be the same as profit. This may happen in a one man accountancy firm but not for most other businesses. Here the base used in the calculations would be the turnover - but this is arguable and it may be stretching the real numbers.
However, there are exceptions: the tech sector, where the turnover is used as a proxy for the market share. Here, a business with $100 million turnover in a $150 million market would have the major share of the market and hence has the competitive advantage.
A business with the major market share would usually be evaluated based on its turnover or the percentage of its market influence and other factors.
2. The Multiple Of Profit Does Not Always Equate To A Business’s Worth
The belief: take last year’s profit of the business and multiply it by a ‘magic number’ and that is the business valuation.
Again, there is no logic in this belief because profit is not the only determining factor of a business value - two businesses generating exactly the same profit may have (i) contrasting asset profiles or (ii) different prospects.
(i) There is a chance that one business would own a property worth several millions while the other has no fixed assets. The former then has more value in addition to its earnings hence it has a higher price in the market.
(ii) One business may be highly dependent on the owner while the other may have a sound management team with a healthy historical financial growth. Hence the latter will naturally be more attractive to buyers and achieve more times the profit after the sale transaction; the former may struggle to get even one times the profit.
Business values calculated using the ‘multiple of earnings’ are usually done after the sale transaction by a neutral third party; the multiples are then expressed in graphs that help to analyse median multiples.
The ‘multiple of earnings’ is related to the industry. Some industries have higher multiple, which can be an illusion for two reasons:
Median values are not the full range of possible multiples for the industry.
Some industries, such as manufacturing, have higher infrastructure costs so their businesses have higher profit margins and a higher value of net assets.
Also, the EBIT (or EBITDA or Seller’s Discretionary Earnings) can be manipulated, hence reiterating that by plainly using multiples will not be an accurate way to value a company.
In conclusion, ‘profit’ is only a part of the calculations, not the only criteria for business valuation.
What about ‘gross profits’?
This is about net profits after all the expenses. Buyers pay little attention to GP as they are more interested in what they will be receiving after the transfer of ownership, and how they can keep it.
For a business, having varied business valuation results from different valuation methods allow adjustments for the subjective factors involved in a business valuation. Hence even the law does not advocate a particular valuation method and they decide on a case by case basis.
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