When it comes to the sale of a business there are many factors that determine the monetary value of a company before it’s sold. These guidelines and values are used to help determine a fair selling price that makes sense for the current business owner, as well as provide an idea to the buyer of how much they should be offering for the company’s sale. Guidelines such as EBIT and EBITDA are individually useful to determine a base monetary value that reflects how much a company is worth. Two other parameters to consider are a company’s book value and its market value.
Book Value
A company’s book value is defined as its worth according to its financial records. It’s generally calculated as the company’s net worth:
- Total Assets – Total Liabilities = Book Value
It’s what a business is worth on paper when those two numbers are subtracted. While a book value of a business may stay the same by accounting measures, the book value of a company can grow as well with the accumulation of earnings. A company’s book value is typically what is used to calculate income tax rates for the business. In New Zealand businesses are taxed at a flat rate of 28%.
Market Value
On the other hand, market value changes according to what the market looks like. Market value is what the company is deemed to be worth in the current business marketplace. It can fluctuate significantly over time, depending on business cycles and what the overall outlook is for buying and selling. Market values tend to dip during recessions or a bear market trend while, in general, they rise during times of bull markets that encourage economic development and expansion.
Why Are These Values Important?
Book value and market value are important because they each tell different stories. A company might be worth $100,000 on paper, but if it’s a small start-up company that’s conducted innovative research and made a name for itself in its industry’s niche, this might give it a slightly higher market value compared to what it’s worth on paper. Another plausible scenario is a company’s market value might help it draw a more competitive price when it’s up for sale if there’s not much competition in its specific industry and if the market is growing.
These values can be used to determine what a fair price for a business would be. While book value takes into account the amount of revenue a company has, the market value takes into account contextual factors, things that are not necessarily measurable by a precise number, but instead are based on subjective things such as the current market performance and the amount of competition out there.
Investors should keep these two methods of valuing a company in mind when they begin the process of buying or selling a company, whether through a business broker or independently. It can help form a clearer picture of a company’s worth when both the book value and market value are considered and weighed against each other.
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