Businesses are beset by a host of risks every day. But sometimes the economic shifts are truly epic.
Whether a financial markets debacle or natural disaster, their effect on the economy and business fortunes may be abrupt and profound. Once high flying companies could face the headwinds that are impossible to foresee.
So if a company swings from being profitable to losing money, what is the effect on its business value?
Ask a professional business appraiser about how to value a business and you will hear that there are three ways or approaches to measuring the business worth:
- Market – based on comparison to similar business sales.
- Asset – which looks at the values of business assets and liabilities.
- Income – where you determine what a business is worth based on its income and risk.
The good thing is that you can value any business using these approaches, regardless of the company’s current financial performance.
Put differently, a business that is not profitable at the moment, may still have considerable economic value, and be worth quite a bit of money.
Business value depends on the long-term earnings outlook
Remember that all business valuations are forward looking – your business value is defined by the future business prospects. And there is a number of things business people can do that affect their business worth. For example:
Business owners may decide to merge businesses that lose money. The combined company may enjoy advantages that drive profitability: better product bundling, access to new markets, lower costs due to economies of scale from combined operations, and much more.
A business can attract smart investors that bring not just money but considerable managerial skills to the table. This may help the company develop new products and services, enter new markets, and turn its technology and know-how to profitable use.
Over time, the company owners may introduce operational changes that cut costs and improve efficiency. Long-term employees are often an excellent source of ideas to maximize profits and how to implement them to contribute to the bottom line.
Putting the business up for sale
Of course, the company owners may decide to sell the business. Can an unprofitable business sell? Yes – provided the right type of business buyer is found. Some typical types:
Financial business buyers
Typically savvy investors that focus on low-cost income streams. They tend to look for low-debt, highly profitable companies. These market participants often focus on the so-called cash cows, businesses that tend to generate steady income year after year.
Synergistic business buyers
These may be a group of investors or a larger company looking to grow through acquisitions. Such buyers may well be interested in the acquired company’s longer-term potential beyond its immediate profit numbers.
Business valuation models and methods for unprofitable businesses
Market comparisons to similar established companies are an excellent way to estimate what your business is worth. You have quite a choice of standard valuation multiples that relate the business potential selling price to its financial fundamentals.
Valuation multiple choices that work well
For an unprofitable company, the following valuation multiples are especially useful:
- Business selling price to gross revenues or net sales.
- Business selling price to business assets, such as total assets or tangible assets.
- Business selling price to book or market value of business equity.
If you plan to re-capitalize the business or sell it to a well-funded buyer, the valuation multiples based on business revenues or asset base are very useful. Selling price to total assets is especially well suited for valuing a business that has both tangible and intangible assets, such as intellectual property, customer lists, valuable distribution rights, and the like. Think valuation of a high-tech start-up that hasn’t turned a profit yet.
The valuation multiples based on profitability, such as discretionary cash flow, EBITDA, or net income, will likely paint an unfavorable picture of what the business is worth.
Business valuation based on future income
This well-known method lets you calculate business value based on the company’s earnings forecast and risk assessment. Typical forecasts are done for 5 years, followed by the estimate of the business long-term terminal value.
Asset based business valuation methods
You can also use asset business valuation methods, such as asset accumulation or capitalized excess earnings. A well-established company may command considerable goodwill, despite the current slide in profitability. To calculate business goodwill, you will need to use the earnings estimate that represents the long-term business earning potential.
Your business valuation model may include a number of methods to determine what the business is worth. This multi-faceted approach is typical of professionally done business appraisals and tends to produce accurate, defensible results.
Take a look at the sample business appraisal report to see how the results of different valuation methods are consolidated into a comprehensive conclusion of business value.