1. Be clear why you need a valuation
The same business can reasonably carry different values depending on the question being asked. An owner planning an exit wants to know what the market may pay. A buyer wants to know whether an asking price is supported. Divorce, shareholder, probate and tax matters can involve specific valuation bases and reporting requirements. Fixing the purpose and the valuation date first avoids answering the wrong question.
2. Gather the right information
- At least three years of statutory or management accounts
- Year-to-date trading figures and, if available, a forecast
- Details of owners' salaries, dividends, pension contributions and benefits
- One-off or unusual income and costs
- Key customer, supplier, employee and lease information
- The balance sheet: debt, cash, working capital and significant assets
3. Find the maintainable earnings
Most valuations of profitable SMEs begin with EBITDA — earnings before interest, tax, depreciation and amortisation — because it gives a view of operating profit before financing and accounting choices.
Reported EBITDA is rarely the right figure on its own. It is normalised to show what a new owner could expect to earn on an ongoing basis. Typical adjustments include:
- Owner remuneration — replacing what the owner takes with a market-rate cost for the role they perform
- One-off items — a legal dispute, a relocation, a large non-recurring contract
- Personal costs run through the business
- Related-party arrangements, such as below-market rent paid to the owner
Every adjustment should be evidenced and explained. Buyers will challenge adjustments that look optimistic.
4. Choose an appropriate valuation method
Earnings multiple
Maintainable earnings are multiplied by a figure reflecting the risk and growth prospects of that business. This is the most common approach for established, profitable SMEs. The multiple is a judgement informed by evidence such as comparable transactions where reliable data exists — not a fixed number for a sector.
Discounted cash flow (DCF)
Future cash flows are forecast and discounted back to today at a rate reflecting risk. DCF suits businesses with uneven growth or heavy planned investment, but the result is sensitive to the forecast and discount rate, so it should be tested against other methods.
Net asset value
The balance sheet is restated at market values. This is relevant for property-rich or holding businesses, or where profits are low relative to the assets employed. For a profitable trading business, assets often set a floor rather than the value.
Where appropriate, using more than one method and reconciling the results gives a more robust conclusion.
5. Adjust for what makes the business more or less risky
Two businesses with identical profits can be worth very different amounts. Factors that commonly push value up or down include:
- Dependence on the owner for sales, relationships or know-how
- Customer concentration — how much revenue relies on a few customers
- Recurring or contracted revenue versus one-off sales
- Profit trend and the credibility of forecasts
- Quality of financial records
- Lease terms, key staff retention and competitive position
6. Move from enterprise value to equity value
An earnings-based valuation usually produces enterprise value — the value of the operating business. What a shareholder actually receives is equity value, which broadly means enterprise value less debt and debt-like items, plus surplus cash, with an adjustment if working capital is above or below a normal level. This step is often where owner expectations and buyer offers diverge.
7. Present a range, not a single number
A valuation is an opinion based on stated assumptions. Showing a range, and how sensitive the value is to the key inputs, is more honest and more useful in negotiations than a single figure. The price eventually agreed also depends on deal terms, the buyer's circumstances and market conditions at the time.
Common mistakes
- Applying a "rule of thumb" multiple without considering the specific business
- Valuing on turnover alone
- Forgetting to replace the owner's salary with a market cost
- Confusing enterprise value with what lands in the seller's bank account
- Relying on online calculators for an important decision
When to get an independent valuation
A self-assessment is a useful starting point. An independent valuation adds an objective view, documented assumptions and a clear methodology — particularly valuable before going to market, before making an offer, or where the value needs to stand up to scrutiny from another party.
See our business valuation service, our guidance on selling and buying a business, or view our fixed fees.
This guide is general information, not advice on any particular business or situation.