If you are valuing a business based on its income, a major part of the challenge is coming up with accurate discount and capitalization rates. These factors capture the company’s risk – and affect the accuracy of your business appraisal.
You can determine the discount rate appropriate for your business by using the well-known Build-Up Model.
Market and company-specific risk
While some elements, or risk premia, can be determined by observing the overall capital markets, you also need to assess your particular business risk profile. This additional element gives you the important component of the discount rate – the company-specific risk premium.
Ten-factor company specific risk assessment
ValuAdder business valuation software gives you a consistent way to evaluate your company specific risk. You can do so by assessing ten important risk factors:
- Business revenue growth prospects.
- Company’s financial risk. Debt-free firms have much lower risk of financial failure than heavily leveraged businesses.
- Operational risks. Consider the difficulty and costs associated with growing your business.
- Business profitability compared to its industry peers.
- Customer concentration. A business with many customers is less risky than a company that relies on a few large customers for most of its income.
- Product concentration. A rich, diverse product mix reduces business risk – and contributes to higher business value.
- Market concentration. Compare a business that sells into many different markets to a company whose market is limited.
- Competitive position. A company in a well-protected market niche is less risky than a firm exposed to large, well-funded competitors.
- Quality of management team. Experienced business managers tend to make good decisions that reduce risk and contribute to higher business valuation.
- Quality of staff. Long-term employees are a great business asset. Their skill and dedication are major value-creating factors in any company.