A Simple Way to Assign Value to a Company

If a company is not profitable today and paying back investors today, you should probably wait until your portfolio is a little large to take a risk on that company.  If a company is profitable with a nice revenue stream and you own either all of the company or just a portion of that company, than that ownership is an asset.

How do you include the value of this asset in your net worth calculation?

For starters, an article at moneyterms.co.uk talks about the valuation of such a company.  I have a nice easy trick.  If the company generates an income stream of $40,000 per year, this company is approximately worth $800,000.

Think about this.  If you wanted to generate $40,000 per year from a retirement account, how much money would you need in the bank account?  That's right, assuming a 5% payout, you would need $800,000.  A company generating $40,000 per year should be purchased for roughly $800,000.

One of the keys is to use the same conversion factor over time.  I used the standard 5% ten years ago and still use it today as several municipal bonds, which are relatively safe investments are paying this out even in today's economy.

In this article, there is an oversimplification because a company may also own property.  However, these can simply be added to the value of the company.

What do you think?  Should a company's valuation be simple the sum total of its revenue stream and current assets?

This post was reposted from http://finlit.biz/business/a-simple-way-to-assign-value-to-a-company/, originally written on February 10th, 2013.