For the purposes of Key Person [Keyman] Insurance - Part 2

In this part two of our Business Valuation series we look at what the right valuation approach might be for your business.

To know what your business is really worth, you need to identify the most appropriate valuation methodology.

Five methodologies are used in over 95 per cent of small to medium size business valuations: capitalisation of future sustainable earnings, discounted cash flow, net realisable assets, industry method and cost to create.

Capitalisation of future earnings focuses on the earnings or adjusted profits.  It values a business at a multiple of its earnings, with the multiple being determined by the risk rating of the business.

Most SME’s have a multiple somewhere between one and five times.  This approach is commonly used for mature businesses where there are reasonably stable earnings.

The discounted cash flow method looks at the free cash flow of the business and calculates value based on the sum of the forward cash flow adjusted to its net present value.

This method is commonly used for businesses where there is a defined time life to the business and where cash flow is reasonably predictable.

As the name implies, net realisable assets simply focuses on the tangible asset value of the business.

The approach ignores the existence of any goodwill and assumes that value exists principally in the realisation of the assets held by the business.  This approach is commonly used for farming businesses or businesses where there is significant investment in plant and equipment or other assets.  Some heavy engineering or road transport businesses may use this approach.

The industry method is the least scientific and is sometimes criticised for its lack of rigour.

It assesses value by a simple formula that will be calculated against some factor of the business such as revenue, gross profits or recurring income.  It is only used for small businesses and seeks to reflect market activity.

The businesses all typically have a very similar business model.  They include cafes, newsagents, pharmacies, real estate agents and financial planning practices.

The cost to create method has emerged recently due to the large number of micro businesses.  It values a business on its tangible assets plus a limited premium for goodwill based on the fact that a buyer would prefer to pay for having the business established rather than incurring the cost, risk and time of trying to establish a small business.

This goodwill premium is normally limited to up to one year’s net income.

Failing to select the right methodology can result in an inaccurate assessment.

Valuation methodology is not simply determined by the industry or sector you are in.  It is also influenced by the size, age, profitability and other characteristics of the business.

Part 3. Valuation Method Hinges On Purpose
In the third part of our Business Valuation series, we look at valuing micro businesses such as retail shops, small services such as trades and other smaller SME’s including cottage industries. Go to Part 3

Key Person Insurance Services from RGIB Insurance Broking

RGIB Insurance Broking provides specialist insurance services for all Key Person [Keyman] Insurance requirements and can tailor solutions specific to your business’s own particular needs; including,

• analysing your ‘Key Person insurance requirements;
• calculating the level of cover to suit;
• helping to establish acceptable cover limits for key people;
• liaising with your accountant to get the figures right;
• helping to establish a value on the business/practice;
• helping to formulate Buy/Sell agreements for succession planning;
• negotiating with underwriters to tailor the best insurance cover at the most affordable premium;
• obtaining insurance premium funding;
• helping manage the ongoing Key Person insurance program – annual level reviews as well as at a time of claim to help ensure that the money goes to the right people at the right time.

It’s imperative to have an insurance broker such as RGIB arrange your Key Person insurance so as avoid any unnecessary complications at benefit payment time.

RGIB is Australia's most innovative insurance broker arranging more than AUD$5.5 Billion cover for over 6,000 business, liability & indemnity SME clients.

Specialising in business, public liability and indemnity insurance with Australian and International insurance companies ensuring clients a professional, efficient & fast service at the best available terms.