Valuing a Business
There
are many different ways to work out the value of a business. For the small
to mid-size business, there are 3 main approaches that are used more than
others. These are the Income value, Market value and the Asset value.
In
brief, the options for valuing a business would be described as follows:
Valuation based on income: Here one is looking at the potential
earning power of the business into the future. Past earnings, expected
future growth, owner compensation adjustments, and specific risk factors,
such as customer concentration, weak management and lack of
diversification are all taken into account when income based valuations
are used.
Market Valuation: This method of valuing a business is similar to the
way one values a house when selling it. What is being looked at here is
what the market will pay for the business in question. Basically, one
collects information on the sale of comparable businesses within the
industry that the business is in.
In both
Income valuations and Market valuations, we will find a price multiple.
This is usually price divided by gross sales and price divided by
earnings. The applicable price multiple is selected primarily on the
profitability of the business. For example, a business with high profits
would have a higher price multiple applied to it. A business with low
profits would be assigned a lower price multiple. When using this
approach, one gets a more accurate result when one uses a minimum of about
a dozen comparables.
Asset
valuation: This valuation procedure assumes that a business is worth
the fair market value of its tangible (physical) assets plus its
intangible assets. Then from these total assets, liabilities or debts are
deducted. To value a business that has intangibles, several methods are
used. The method that is most employed in this area is the 5-step excess
earning calculation. That calculation deals with tangible assets,
intangible assets, liabilities and adjustments thereof, to arrive at an
estimated value for the business. It figures out what the reasonable
return is on the assets of the business should be. If the profit is
greater, then the business has some intangible assets that are making the
excess profit.
If the
company in question is not making a lot of money, then there will be no
intangible. In this situation, the asset valuation method is usually used
when a business has capital tied up in equipment and other tangible assets
and the other valuation methods come up with a price below the actual
asset value, without any good will. A seller wants to get at least what
the equipment is worth; so then this method is used.
Willard Michlin is an Investor, Business Broker, California Real Estate
Broker, Accountant, Financial Distress Consultant, Well known Public
speaker and Administrative/Business Consultant. He can be contacted at his
Ventura, California office by calling 805-529-9854 or by e-mail at
kismetrei@earthlink.net See other article by Willard at
http://www.kismetbusinessbrokers.com
