Small business valuation is an accounting method that helps a company determine its worth. The valuation is usually conducted before a sale, acquisition or merger. Companies may choose between several different models, but they all achieve the same goal: determining fair value.

What is Business Valuation?

According to Investopedia, “A business valuation is a general process of determining the economic value of a whole business or company unit. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation, and even divorce proceedings. Owners will often turn to professional business evaluators for an objective estimate of the value of the business.”

Why Small Business Valuations Matter

Small business valuation is more than an exercise. It is an important exercise for income tax reporting. The Internal Revenue Service (IRS) requires that a business is valued based on its fair market value. Some major events, like the sale or purchase of a company, are often taxed based on the valuation of a small business.

3 Common Types of Small Business Valuation Methods

1)      Asset-Based

Asset-based valuations examine the assets and liabilities of a business to determine its worth. For example, if you have $200,000 in assets and $40,000 in liabilities, the value of your business would be $160,000.

2)      Market Value

The market value method determines valuation by comparing your business to the valuation of similar companies. In order to use this method, you will need to have sufficient market data on competitors.

3)      Earnings Value

The earnings value method takes into account a company’s potential for future earnings. This process calculates an expected level of cash flow using past earnings. It is a reflection of what rate of return a reasonable investor could expect on their investments.

Accessing small business valuation is more of an art than a science. You could choose any of these three methods to determine how much your business is worth before a sale, acquisition or merger.

If you have any questions about valuing your organization for income tax or other purposes, contact a local accounting firm.