How to Value a Company: Business Valuation Explained

Let's say I owned a business in the form of a neighborhood shop. To set up that shop, I spent $1,000 last year on equipment and other assets. The equipment and other assets have depreciated by 10% in one year, so now it is worth only $900 in the accounting books. If I were to try to sell you this business, how much would an accountant value it? Simple! $900. The cost of all the assets (less liabilities, if any) will give accountants the "book value" of the business, and this is traditionally how accountants would value a business or company. (We use the word "book" value because the value of the assets are written in the company's accounting "books.") However, what if this company is earning a juicy cash profit of $2,000 per year? You would be getting a mighty good deal if I sold it to you for only $900, right? I, on the other hand, would be getting a pretty sour deal if I sold it to you for its book value of only $900, because then I'd get $900 but I'd lose $2,000 per year!

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