How is the value of a company calculated?

Both for those wishing to sell a business and those looking to purchase one, valuation is a relevant concept. Understanding how a company's value is calculated can help you know when to be satisfied and what to watch out for.

1. Substantial or Intrinsic Value

The substantial or intrinsic value of a business is equal to the sum of the current actual value of each of its components. In other words, what are the assets of the business?

For a sole proprietorship, you'll need to compile a statement of the actual value of all components: inventories, machinery, furniture, etc.

For a company, this is based on the balance sheet. After assessing the assets (land, machinery, receivables, deposits...), debts to third parties are deducted. Generally, the main balance sheet items are adjusted. A business building might be worth only €50,000 on the balance sheet after depreciation, while the actual value might be €1,000,000 due to rising real estate prices.

2. Earnings Value

This method uses the company's past profits as a starting point. In other words, what is the profit of the business?

This approach often uses several rules of thumb to get an initial indication. Such rules are only indicative.

4 x net profit (or the sum of profit over the last 4 fiscal years)
0.3 to 1x the annual turnover
3 to 9x the EBITDA depending on the sector and size of the company (see the annual Vlerick M&A monitor)

3. Future Income

The value of a business is mainly determined by its future returns and the free cash flow remaining after compensating the business manager and after foreseeable (replacement) investments.

Rule of Thumb: the future free cash flow should allow the recovery of the acquisition price over 5 to 7 years. Note: Different rules apply if the business has a substantial real estate component.

DCF Method

This approach uses future net cash flows as a starting point. The company's value is determined using the "cash flow approach," better known as the 'discounted cash flow method.' This method is based on the sum of future net cash flows, forecasting the next 3 to 5 years. These future cash flows are then discounted to their present value using a discount rate.

Conclusion

The methods outlined above provide an idea of the variety of calculation methods and principles used.

It is often suggested to work with some combination of methods. Whether a certain valuation is suitable will need to be determined on a case-by-case basis. It usually remains a complex matter, and depending on the intended goal, it's best to consult an expert advisor.

When you need to estimate your company's value, it's best to get advice from an expert.

The SME advisor uses various valuation methods for this. You'll receive a clear insight into the valuation of your business and a personalized explanation.

Based on such a professionally substantiated valuation, you can:

• Make timely preparations to get your business ready for sale
• Be better equipped in price negotiations with the buyer
• Develop a realistic price for a family transfer

Specialized SME advice is a contractual and paid service. The SME advisor gives you a clear view of your company's valuation without jargon.

Request a valuation for your company.