Valuing a business can feel mysterious - like a dark art only reserved for accountants or investment bankers. But it doesn’t have to be. At its core, the value of any business is driven by a simple relationship:
Value = Future Earnings ÷ Risk
This isn’t a formal formula, but it captures the logic behind almost every valuation method out there. The more profit a business is expected to generate in the future, the more it’s worth. The more risk or uncertainty there is around those profits, the less it’s worth.
Let’s unpack that.
1. Higher Earnings = Higher Value
This is the most intuitive part. A business making R1 million in annual profit is usually worth more than one making R100,000. Investors, buyers, or shareholders are essentially buying access to future cash flow. So the higher the sustainable earnings, the greater the value - simple as that.
But we’re not just talking about today’s profits. What really matters is how much the business will earn in the future.
2. Growth Matters: A R900k Business Could Be Worth More Than a R1m One
If a business is growing fast, its future earnings will likely exceed its current earnings. That means more value today. For example, a business earning R900,000 this year but doubling its profits annually could be worth far more than a flat business earning R1 million with no growth prospects.
Growth can come from various sources: entering new markets, launching new products, increasing prices, or improving margins. If the market sees a clear and realistic path to higher future earnings, the valuation rises.
3. Risk Pulls Value Down
Now, the other half of the equation: risk. Risk is why R1 million today is more attractive than R1 million in five years. It’s also why investors discount the future: because things can go wrong. The more uncertain or volatile the business’s future earnings are, the lower the value today.
Risks could include customer concentration (reliance on one or two big clients), industry disruption, high staff turnover, regulatory exposure, or simply inconsistent financial performance. All of these increase the discount rate applied to future earnings: reducing the present value of the business.
Putting It All Together
So what is your business worth?
Start with how much profit it’s earning (or will earn), think about how fast that profit will grow, and then honestly assess how certain or risky those earnings are. You can think of it as:
Business Value = Expected Future Earnings ÷ Risk
This principle holds true whether you're doing a simple price-to-earnings multiple, a discounted cash flow model, or back-of-the-envelope estimates for a potential investor.
It’s not a perfect science, but it is a helpful framework. And the better you understand it, the more strategic you can be in building value into your business over time. Grow the earnings. Show the growth potential. Reduce the uncertainty. That's the game.