Business valuation is a complicated process. You may start by looking at what you have and estimating the value of each item. However, your valuation may not even come close to the actual selling value, which can be determined through the application of standard valuation methods.
Your Own Valuation – A Good Starting Point
This is not to say you just sit there and let others do the calculation for you. It is a good idea to have an inventory of your assets and to manually check what you have. Otherwise, the tendency will be to just take others’ valuation at their face value.
So what do you have there? Equipment? Tools? Properties? These are your tangible assets. Look also into the intangible ones like business goodwill, brands, and intellectual property.
Regarding pricing, you can just target the replacement cost and not go higher than that. If you will be operating in the future in the same industry, using replacement cost is a good idea.
It is also advisable that you check your books and get them ready for expert scrutiny. No one will buy your business without evaluating first the business’s profitability. Organize your business documents.
Other Ways of Valuation
Businesses are valued in different ways, and these different methods are applied differently in different industries. Know your industry and focus your research in this industry. Below are common valuation methods.
The simplest value approximation of a business involving stream of cash is revenue. A business with revenue of $200,000 is considered to be worth that value.
In actual transactions, however, this is not often the value that’s expressed. Rather, some multiples are considered. For example, if the multiple basis is “two times”, that means the 200,000 figure value stated above has a sell value of $200,000. This method is called the “Times Revenue Method”, the purpose of which is to determine the maximum value of a business.
Multiplies are written in the form of a number followed by the letter “X” (e.g., 2X, 3X, 4X, and so on). A business can also be valued using 1X or even lower.
Assume that ABC Company’s revenue over the last fiscal year is $400,000. Using this method, the company can sell anywhere between $200,000 (half-time revenue) and $800,000 (two-times revenue).
The method is best applied for younger companies with very volatile earnings. Companies projected to grow speedily in the short-term would ideally use times revenue for their valuation. The multiple can be higher if the industry or company is poised for growth or expansion.
Now, revenue is not profit, and the profit aspect seems to be more important to many buyers than revenue. They will look into this aspect of your business because everybody is just making sure that they can earn money for all the hard work that they will be putting in.
Take Amazon for example. It made $4 billion in sales back in 2002. But when you check deeper, you will see that it is not making any profit at all. They are actually in the negative. The giant online retail store did not make a single cent of profit since it started operations. Latest estimates have it that Amazon is even pumping in about $380 million per year just to keep its business afloat.
In your profit and revenue valuations, don’t be overconfident, as market conditions fluctuate. Factor in competition, changes in supplier prices and the possibility that your industry can decline any time in the future.
SDE (Sellers’ Discretionary Earnings)
They may also look into your business’s SDE. For some, this method of business valuation is more reliable than just determining the net income. According to them, SDE is the best measure of the earning power of a business.
SDE is the net income before the primary owner’s compensation and benefits, taxes, interest, and depreciation are deducted. Perks like entertainment, meal, personal travel, health insurance, and company cars are also included.
Interest expense also factors in, as it is assumed that the would-be buyer will not shoulder the business’s debt. Amortization and depreciation are also included as they are not considered as expenses. Taxes also form part of the SDE since the new owner will have a different tax expense. Along with these items, non-operating expense and income, non-recurring expense, and sale of an asset are also included in the computation.
Get Appraisal Services
Talk to companies offering appraisal services. The cost of getting such services is usually modest, and these services are often conducted with no obligation. Consider talking to two or three companies before making the decision to sell.