Most small business owners have no idea how to determine the worth of their business. They plan on selling, but never take the time to figure out what their business is really worth. And knowing is the start of the plan. Fortunately, a buyer only cares about one thing. The numbers. There are a handful of methods for determining the worth of your small business. Read on to learn all about those different types of tools for determining the worth of your small business.
A Brief Overview
The worth of a business can be determined in a number of ways. However, there are three accepted valuation approaches: income, asset, and market-based. Different approaches can often lead to considerably different results. As can the way numbers are reported in the business.
Income-based appraisals use current and past income of the business to help predict future income for a potential buyer. Three different income-based methods are listed below.
Multiples of Discretionary Earnings
Most small businesses use this approach. A business owners discretionary income and benefits are averaged over a 3 to 5 year period. They are then multiplied by another number, referred to as a multiplier. Multipliers are based on industry classification, which can vary significantly from one industry to the next.
Discounted Cash Flow Method
The discounted cash flow method is essentially about looking at the potential for future income. It requires the business owner to determine the present value of the future revenue. The future income is adjusted based on the perceived risk of the business. This approach is most effective for newer businesses with a lot of potential.
Capitalization Of Earnings Method
The capitalization of earnings method also looks to the potential income of a business. However, accounts usually reserve this assessment for more well-established businesses. This is because more factors go into the future income tallying. Business owners need to determine current level of revenue, annual return on investment, and expected business value. The expectation here is that the value determined for a certain period of time carries into the future.
The asset-based approach is determined by adding together all of a business’ assets and liabilities to arrive at a value. Those assets include a wide range of options.
- Real estate or physical location (must own, not lease)
- Any other property owned by the business
- Any inventory or products. For example, tools or stock on shelves
- Intangible assets, such as the value of a savings account
Market-based valuations depend entirely on comparing one business to other businesses in the industry. Business owners need to be honest about their business and look at something that is truly similar. For example, if a 100 seat Italian restaurant is sold for one million dollars, do not expect a 40 seat dive bar to go for the same amount. Additionally, always use a local market. Small town prices are pretty much always lower than big city ones. This is suitable for nearly any business, as long as the industry has enough movement in it. While it is suitable for anyone, it is conducive to businesses or industries that are rapidly growing.