subject: Let me ask you...Have you ever wondered how to value a business? [print this page] Let me ask you...Have you ever wondered how to value a business?
A couple of weeks ago I stumbled upon an old post from a forum I frequently visit. Someone was asking a question about how they should go about valuing a business. 12 people were good enough to reply. It didn't surprise me when all 12 replied with totally different solutions on how to value a business. You would have to assume that those taking the time to respond were pretty confident that they knew the correct answer. It got me wondering where they actually got their methods from and just how much confusion this subject creates, not only business buyers and business sellers but with almost everyone including accountants and business brokers!
So, you may be asking "how do I go about establishing the asking price of a business"?
The Business Brokers method for Valuing a Business
Business brokers use this method to arrive at the asking price for a small business; it is calculated on the adjusted net profit using the most recent profit and loss statements supplied by the seller. The business broker will look at all the business expenses to see what they can add back to profit. This is usually referred to as add backs or recasting. The adjustment is made by adding back to the net profit - the total amount of non-essential or discretionary expenses, which are not necessary to run the business, so to show a more accurate net cash flow for the owner.
The business may also have unaccountable business expenses. A clear example may be the business rental expenses, if the owner also owns the freehold and is looking to sell the leasehold only, you would need to make certain that the rental expenses were correct and adjust the profit if necessary - in this case it would be adjusted downward.
Once this number is determined, the following step a business broker will take is to multiply the adjusted net profit usually by 2.5 times and they have their figure.
Let me share an example of the business broker method with you.
Business A: Established 12 years, trades 9-5 Mon Fri with consistent sales, strong industry growth, selection of quality suppliers, and abundant customers etc.
Business B: Established 2 years, operates 7 days a week, sales are inconsistent, cut throat industry with aggressive competition, and it only has one customer.
For this example, both businesses A and B show $100,000 adjusted profit after the owner operator wage is taken out. The business broker will then use the same multiple on both businesses i.e. 2.5 x $100,000 = $250,000. This will include stock, the written down value of the plant and equipment and the goodwill.
As you can clearly see this method does not make a great deal of sense.
As a business buyer or business seller it is important for you to never assume that the asking price of the business is anywhere close to the correct, value even when it is set by so called professionals.
You can be talking hundreds of thousands of dollars either way. Frightening!
The good news is that there is a way you can accurately value a business with peace of mind that it will be valued on its own merits. My advice is to look for a valuation software tool which provides a clear method of taking everything about the business into account for an accurate result.
p.s ..and for sure, it must be easy to understand and use
