Business Valuation: Methods and Tips to Maximize Value

                                                                                                                                                                                          As a business owner, you pour your heart and soul into building and growing your venture. Whether you have plans to sell your business, seek external financing, or simply have a grasp of its worth, understanding how to value your business is very important.

                                                                                                                                                                                          Understanding and determining a valuation for your business allows you to make informed decisions about its future. 

                                                                                                                                                                                          In this article, we will explore the main reasons for business valuation, the most-used valuation methods, and share valuable tips to maximize valuation.

                                                                                                                                                                                                                                                                                                                    Why Do You Need To Value Your Business?

                                                                                                                                                                                                                                                                                                                    1. Sale or Exit Strategy

                                                                                                                                                                                                                                                                                                                    If you plan to sell your business, a valuation is essential to determine an appropriate selling price. Understanding the value of your business can help you negotiate effectively, attract potential buyers, and ensure a fair transaction.

                                                                                                                                                                                                                                                                                                                    Selling your business is a complex and long process, so make sure to hire competent experts to avoid making mistakes and maximize selling price. 

                                                                                                                                                                                                                                                                                                                    Related to this matter, we have talked about Financial Due Diligence - which is a crucial step of the selling process - in one of our previous blog articles

                                                                                                                                                                                                                                                                                                                    2. Attracting Investors

                                                                                                                                                                                                                                                                                                                    In a similar way to when you are selling your entire business, investors will assess the value of your business before deciding to invest or lend money. A solid valuation will enhance your credibility and increase your chances of securing funding on favorable terms.

                                                                                                                                                                                                                                                                                                                    3. Internal Decision-making:

                                                                                                                                                                                                                                                                                                                    Valuing your business provides valuable insights into its financial health, strengths, and weaknesses. This information helps you make strategic decisions about expansion, acquisitions, partnerships, or other growth opportunities.

                                                                                                                                                                                                                                                                                                                    The Main Valuation Methods

                                                                                                                                                                                                                                                                                                                    Multiple methods can be used to value businesses. The choice of method depends on factors such as the size and nature of the business, its industry, and the availability of financial information. 

                                                                                                                                                                                                                                                                                                                    We will present below three widely used valuation methods. However, before we do so, it is important to keep these points below in mind when valuing your business: 

                                                                                                                                                                                                                                                                                                                    • There is a difference between the Enterprise Value and the Equity Value. Simply put, we have: Equity value = Enterprise Value – total debt + cash. We will be focusing on the Enterprise Value in this article to remove the capital structure from the equation.

                                                                                                                                                                                                                                                                                                                    • There is a difference between the Valuation and the Price. The Value is the amount - or more appropriately the range - that is obtained by using a method and that is the reflection of what a buyer should pay for a company. The Price of a company is the amount for which two independent parties agree to carry out a sale and purchase transaction, which is fixed during the negotiation process.

                                                                                                                                                                                                                                                                                                                    • There will be adjustments made to the Financial Statements. This is to reflect more accurately the actual profitability or cash flow potential of the company. These adjustments include errors made in the recordings but also some normalization adjustments on Non-recurring expense, Owner’s Compensation, Related party transactions, etc.

                                                                                                                                                                                                                                                                                                                    1. Market-based Approach with the Multiples

                                                                                                                                                                                                                                                                                                                    This approach determines the value of your business by comparing it to similar businesses that have been recently sold or are actively traded in the market. Comparable factors may include revenue, profits, assets, industry multiples, or other relevant metrics. 

                                                                                                                                                                                                                                                                                                                    The basic idea behind the multiples valuation methodology is that the market price of a similar asset or company can serve as a reasonable estimate of the value of the asset or company being valued. By identifying comparable companies or assets that have similar characteristics, such as industry, size, growth prospects, and risk profile, analysts can derive valuation multiples. 

                                                                                                                                                                                                                                                                                                                    Most commonly used enterprise value multiples include Sales and EBITDA multiples.

                                                                                                                                                                                                                                                                                                                    Example of an EBITDA Multiple Computation:

                                                                                                                                                                                                                                                                                                                    EBITDA = Earnings Before Tax + Interest + Depreciation + Amortization

                                                                                                                                                                                                                                                                                                                    Market Capitalization: 250M USD
                                                                                                                                                                                                                                                                                                                    Cash: 2M USD
                                                                                                                                                                                                                                                                                                                    Debt: 50M USD
                                                                                                                                                                                                                                                                                                                    Enterprise Value: 202M USD

                                                                                                                                                                                                                                                                                                                    EBITDA: 16M USD

                                                                                                                                                                                                                                                                                                                    EBITDA Multiple: 12.63x

                                                                                                                                                                                                                                                                                                                    Valuation of a Private Company:

                                                                                                                                                                                                                                                                                                                    For private company valuation, by definition their shares do not trade on public exchanges, but you can still use the Market-based approach with the multiples. 

                                                                                                                                                                                                                                                                                                                    However, all else being equal, a private company is worth less than a similar publicly traded company. This is because investors prefer liquid, publicly traded companies. Therefore, a discount to the private company is applied due to this lack of liquidity and marketability.

                                                                                                                                                                                                                                                                                                                    2. Income-based Approach with the Discounted Cash Flows

                                                                                                                                                                                                                                                                                                                    This approach focuses on your business's ability to generate future cash flows. Methods such as the discounted cash flow (DCF) analysis estimate the present value of expected future cash flows by considering factors like revenue, expenses, growth rates, and risk. 

                                                                                                                                                                                                                                                                                                                    This approach is effective when your business has a strong track record of generating consistent income. The major limitation of discounted cash flow analysis is that it involves estimates, not actual figures.

                                                                                                                                                                                                                                                                                                                    3. Asset-based Approach

                                                                                                                                                                                                                                                                                                                    This approach determines the value of your business by assessing its tangible and intangible assets. Tangible assets may include property, equipment, and inventory, while intangible assets encompass intellectual property, brand value, customer relationships, and goodwill.

                                                                                                                                                                                                                                                                                                                    An asset-based valuation seeks to identify the market value of assets in the current environment. Balance sheet valuations use depreciation to decrease the value of assets over time. Thus, the book value of an asset is not necessarily equivalent to the fair market value.

                                                                                                                                                                                                                                                                                                                    There is some room for interpretation in terms of deciding which of the company's assets (and liabilities) to include in the valuation and how to measure the worth of each.

                                                                                                                                                                                                                                                                                                                    This method is valuable when the asset value is a significant driver of your business's worth.

                                                                                                                                                                                                                                                                                                                    Tips To Maximize Valuation

                                                                                                                                                                                                                                                                                                                    Now that we understand the importance of valuing your business and the main methods to determine its worth, here are some tips to maximize your business's valuation:

                                                                                                                                                                                                                                                                                                                    1. Strengthen Financial Records

                                                                                                                                                                                                                                                                                                                    Maintaining accurate and up-to-date financial records is crucial. Clear and transparent financial statements provide potential buyers or investors with a comprehensive view of your business's performance, profitability, and growth potential. You can learn more about Financial Reports in a previous article here

                                                                                                                                                                                                                                                                                                                    Also being able to present your figures in detail with analytical reports and projections that are relevant for your business is a big plus. You may want to showcase your performance per activity, per types of clients, per locations, etc. Here is one of our previous article on management and segmentation reporting.

                                                                                                                                                                                                                                                                                                                    2. Focus on Profitability and Growth

                                                                                                                                                                                                                                                                                                                    Demonstrating consistent profitability and a strong growth trajectory significantly enhances your business's value. Implement strategies that optimize revenue streams, manage costs, and foster sustainable growth.

                                                                                                                                                                                                                                                                                                                    3. Build a Strong Management Team

                                                                                                                                                                                                                                                                                                                    A capable and experienced management team instills confidence in potential buyers or investors. Surround yourself with talented individuals who possess the skills and expertise necessary to drive the business forward.

                                                                                                                                                                                                                                                                                                                    4. Diversify Your Customer Base

                                                                                                                                                                                                                                                                                                                    Overreliance on a few key customers can be viewed as a risk by potential buyers or investors. Seek opportunities to diversify your customer base.

                                                                                                                                                                                                                                                                                                                    Proseso Consulting - The Finance expert for growing and international businesses

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                                                                                                                                                                                                                                                                                                                    Ninoy Salmon is a seasoned business and finance professional with extensive experience working with both fast-growing startups and companies in the Philippines and around the world.

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                                                                                                                                                                                                                                                                                                                    This blog article does not constitute professional or legal advice. It is only intended to provide general information on a subject.

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