It sure is fast, but how reliable is a business calculator? There are certainly pros and cons to using a business calculation software, with some situations more viable than others. If you’re contemplating using a business calculator, we encourage you to read this article to answer some of the questions you may be (and should be) asking.
What is a Business Valuation Calculator?
A business valuation calculator, performed with software, provides an estimate of value relying on several variables and inputs. When using software, it operates within a limited pre-determined set of calculations based on a specific and limited number of input variables.
Business valuation success is determined by (amongst other things):
- amount of inputs/information, both qualitative and quantitative, given to the valuation professional or software, and the quality and accuracy of those inputs
- ability to interpret the inputs/information and assess their relevance and importance to the valuation of the subject business
Regarding the first point above, valuations are completed based on the information provided (operating within a valuation framework), if there are more datapoints and a higher quality of datapoints, this enables the highest probability of a higher quality, accurate valuation.
Regarding the second point, once you have that information, the valuation’s success is:
- having the freedom to combine both the art and science of business valuations in identifying the relevant information and its importance
- having the valuation experience and knowledge that allows for the most robust and accurate valuation
Why You Shouldn’t Trust an Online Business Calculator
Using a software that has limited inputs and uses limited or confined mathematical formulas will provide a limited valuation number.
This means that a software will deliver a valuation based on the available information and pre-determined calculations, and depending on your valuation purpose, this may not be sufficient. For other purposes, a particular software may have enough accurate inputs, and therefore a level of sophistication that produces a sufficiently justifiable valuation number.
But what would these purposes be? Also, how practical is this in real-world situations? If you’re trying to sell your business for the highest price, and a buyer is trying to buy it for the lowest price, is a potential buyer going to accept or rely on a business valuation calculator for their due diligence on a sale price of $5,000,000?
Example of a Business Calculator
Business Valuation Purposes:
Let’s say that you’re trying to buy a second-hand car, and so you go to a second-hand car sales website. There’s one picture of the car, along with the name, make, and year, and it has a price tag of $20,000. Now, based on those inputs, $20,000 seems like an accurate price. Your friend Bob says this kind of car is worth about that much, and you’ve also seen a few other cars of the same make, model, and year for a similar price. The photo of the car matches the other details and the car doesn’t seem damaged, so this seems to be an accurate valuation based on those limited inputs.
Now, the car might very well be worth exactly $20,000 in the market. However, how justified is that number? Would you be wanting some more inputs of data/information to develop its valuation? Let’s add in that the mechanic that took the car to their garage and performed an in-depth analysis of the engine, body structure, interior, and all the other parts, confirming based on the current condition of the car that it had approximately 50,000 kms of use left, because the car was indeed in poor condition.
This mechanic can’t take the car for a test drive because that’s outside of their job description, so you take the car for a test drive yourself, get a feeling for it, feel the rattle in the acceleration, and then you hear a squeaky noise when braking. You don’t know what that sound means, except for the fact that it doesn’t sound good. Now, based on significantly more datapoints from the mechanic and your test drive, a car with similar characteristics in the market would be valued at $5,000 to $10,000.
If you have less datapoints, more restrictions in analysis (because that’s not part of the mechanic’s job), and less knowledge regarding what makes a car mechanically reliable, you are left to make decisions based on an insufficient level of information. This often leads to a less accurate valuation, which would potentially be very costly.
When Are Business Valuation Calculators a Viable Option?
- the software is robust, has a significant amount of data inputs, and the operator of the inputs/software knows what they’re doing
- the business is very consistent in revenue and profits, and there is little change or volatility in all aspects of the business’ operations and finances
- the purpose of the valuation is less important, it doesn’t need to be tested or reviewed by third parties, or relied on for compliance with tax authorities or litigation purposes
When Do Business Valuation Calculators Have Issues Delivering the Valuation Service?
- the software is basic in nature, requires minimal inputs, and does not have the industry credibility
- the business is expecting its future to be different than its past (is it expecting growth or a decline?) or expects material changes in operations
- Also, is the valuation to be reviewed by a third party (for example, a buyer or the tax department) or to be used in a divorce or partnership dispute?
All of the above considered, you need to ask yourself:
- how accurate do I need the value of my business to be?
- how informed do I want to be?
- how justified do I want the value to be?
- what is my level of risk in this situation if it is not accurate?
- what is the reason I need this valuation?