If you can directly connect your actions to calculating the valuation of your business then you will be able to use this as a guide to understanding which actions are most impactful to growing your wealth.
Firstly, we often hear about valuation in the context of startups and public corporations, but it’s less common to discuss it in relation to small businesses. So, what exactly is business valuation, and how does it differ for small businesses when compared to startups or public corporations?
At its core, valuation remains consistent regardless of the entity being valued. It involves determining the current worth of an asset or company. Nevertheless, the techniques and purposes behind these valuations can vary significantly.
In startup or publicly traded company valuations, the primary objective is often to set a price point for potential investors. However, for a small business that may not be actively for sale, comprehending your valuation and its composition can serve as the linchpin for steering your company towards wealth generation.
Broadly speaking, two primary valuation methods exist, each comprising multiple techniques. The first is the intrinsic valuation method, where analysts aim to predict expected cash flows, their timing, and associated risks. By utilizing these variables, the current value of the company is determined through discounting expected cash flows at an appropriate rate. The second method is the comparables method. In the comparables method, one is trying to use the ratio of the market price of other companies compared to some metric like, market price/net income, or market price/revenue, or market price/# of customers, and then applying that ratio to your business for whatever metric was used.
While I argue that the comparable method is more suited for market pricing, the intrinsic valuation method, rooted in your business’s fundamentals, uniquely enables you to comprehend how your actions influence your business’s value—essentially impacting your wealth. Whether selling or buying a business, the comparables method aids in understanding the price, yet it’s essential to juxtapose the price against the underlying value derived from the intrinsic valuation method to assess the deal’s quality.
When employing the intrinsic valuation method to inform your business decisions, numerous variables come into play. The optimal approach involves utilizing your preferred spreadsheet software to construct a precise financial model. This model should meticulously deconstruct each aspect of your business such that your measurable actions serve as inputs and lay the foundation for accurate forecasts. This means each material aspect of your customer acquisition, revenue, expenses, and operations should be broken down and pieced together in a way that reflects your business as accurately as possible to answer any relevant questions. Each of these variables needs to be easily changeable in your spreadsheet so that we can see how changing them impacts your valuation.
However, a challenge inherent in such models lies in the multitude of inputs. When left to the discretion of an optimistic entrepreneur, even if the model is accurate, inputs may veer into unrealistic territory. This highlights the indispensable role of data collection in adding an element of objectivity.
When you combine proper data collection (https://www.fsadvisors.co/5-benefits-frelancers-harnesing-data/) with a financial model you are best able to make the most accurate forecasts, understand how you past performance has created your valuation. Further, by observing how changing the inputs, in other words changing your actions, would affect your valuation and overall wealth generation your data collections and financial model can serve a guide towards pursuing the most effective course of action.
Moreover, when venturing into new business domains—be it new markets or products—a well-constructed model can illuminate the required metrics you would need to achieve to understand the plausibility of the new venture boosting or hindering your valuation. This equips you with the insights needed to make informed decisions.
In conclusion, by understandings how your valuation is rooted in your actions with the help of a robust financial model fed by your data you can begin to use it as a guide to help you make decisions that grow your wealth.