Determining the value of a business for sale is complex, and there are many methods that can be used to estimate a business’s value. Some estimation methods work better for different types of businesses. This article discusses the methods you can use to informally determine the value of your business if you are considering selling it.
Methods for Valuing a Business
These estimation methods provide you with some ways to explore the value of your own business and get a general idea of where to start negotiating between you as the seller and the potential buyer. Do not assume that any of these methods will give you an accurate number, but they are considered a starting point for the estimation process. In some businesses, you may need to use all of these methods to estimate the business’s value.
Asset Valuation
The assets of a business include all the things the company owns that have value that can be reflected on the balance sheet. Assets include land, buildings, equipment, vehicles, cash, supplies, and accounts receivable. Intangible assets such as intellectual property also have value. Usually, asset valuation looks at the total cost required to create another company with the same assets.
Cash Flow
Some buyers want to know how much cash your business can generate. This method uses information from the cash flow statement that shows the incoming and outgoing cash flows of the business over a specified period. This current figure is then discounted to its future value. Cash flow value is often used to estimate the value of companies with shareholders.
Total Sales
Gross sales multiples, as entrepreneurs say, are the “closest rough estimate” for estimating a business’s value. For example, sales from the past three years can be used. However, there’s no guarantee that this level of sales can be sustained, which is why it is not useful for estimating on its own.
Profit Multiples
For companies with shareholders, looking at profit multiples per share of stock is a common estimation method. Profit estimation is based on the company’s ability to generate future wealth. This figure represents earnings per shareholder, or EPS, which is not the same as dividends distributed as profit. The principle here is that the higher the EPS, the greater the company’s value; profit estimation.
Seller’s Discretionary Earnings (SDE)
The method of estimating seller’s discretionary earnings is similar to profit multiples, but it is used for small businesses with a single owner, such as a professional practice or sole proprietorship. In this method, the gross profit is reduced by several figures so that only operating expenses can be identified: income taxes, non-recurring income and expenses, non-operating income and expenses, depreciation and amortization, and interest or income.
Estimates are usually expressed as a multiple of SDE, ranging from one to four times. The multiple depends on the type of business. Some common multiples are the age of the business, risk, location/facilities, competition, and industry.
SDE and Owner Compensation
Seller’s discretionary earnings may or may not include owner compensation, depending on who is doing the calculation. The International Business Brokers Association states that seller’s discretionary earnings exclude “total owner compensation, including benefits and any non-business or personal expenses paid by the company.” The small business development agency in Colorado states that SDC includes the owner’s salary, whereas EBITDA (earnings before interest, taxes, depreciation, and amortization) does not include the owner’s salary.
Why Business Valuation Methods Are Often Inaccurate
This article presents some methods for estimating the value of a business, but the only true value is the one agreed upon by the buyer and seller after negotiation and obtaining complete information. The more methods you use for estimation, the closer you will get to the correct number. The more figures you compile, the more accurate the estimation will be.
Most
Business valuations are unrealistic because they do not take into account external or intangible factors. Here are some examples of other factors in determining the value of a business.
Economic Conditions
The state of the American economy affects all businesses in numerous ways, and local economies may have a greater impact on your business. Consider economic factors in your projection of your business’s value to a potential buyer.
Location and Market Factors
Business sales, like real estate sales, are all about “location, location, location.” When evaluating the sale price of your business, consider location factors in terms of businesses adjacent to your immediate business, your city, county, and state.
Technology Factors
It can be difficult to determine the value of the level of technology used in the company, but it is a significant factor in selling a business. Your company’s website and any online sales you do, alongside the use of computer programs and applications in all areas of your business, can have a positive or negative impact on the buyer.
Final Note on Business Valuation
The true value of a business is only realized when a ready buyer and seller sit down and reach an agreement and put that agreement in writing. However, having some valuation methods in your pocket as you enter negotiations with the seller can help you focus the discussion and reach an agreement more easily.
Source: https://www.thebalancemoney.com/how-to-determine-the-value-of-a-business-4174994
Leave a Reply