Three things and three things only determine the value of your business or any business. Those are expectations for expected cash flow, growth of that cash flow, and the risk associated with achieving that cash flow. You see every business valuation is a forecast. It’s a forecast of expectations for the future for those three variables. For example, if you have a level of cash flow, it’s expected to grow into the indefinite future and those cash flows are discounted back to the present at a discount rate, r, that is appropriate for the expectations of achieving those cash flows. It’s really pretty much that simple. That discounted cash flow model can be summarized in a little equation: Value is equal to Expected Cash Flow capitalized by Risk minus Growth. All we have to assume is that the growth will be constant over that indefinite period into the future. That is also captured in a simpler formula: Value is equal to Cash Flow times a Multiple.
You’ve all heard about a value of business being worth six times or eight times EBITDA or a public company being traded at 20 times earnings. These are all applications of this basic valuation formula. So, when you think about your business, think about the value of your business. You think about the value as a function of three things, and three things only. Expectations from the viewpoint of real buyers and your own expectations for cash flow, the growth of that cash flow, and the risks associated with achieving those cash flows. If you can increase cash flow, you can increase value. If you can increase the growth rate, the expected growth rate, you can increase value. And if you can decrease risk, you can increase value. So three things to focus on today. The value of your business, or any business, is a function of expectations for cash flow, the growth of that cash flow or those cash flows, and the risks associated with achieving those cash flows in the future.
This is Chris Mercer with a valuation video today.