“What is my business worth?” is a question we often hear. Truth be told, because every business is different, the variables used for determining value will almost always be different. For instance, let’s create a hypothetical scenario and say that Company “A” & Company “B” have exactly the same financial information. The same gross sales, the same net profits & the same cash-flow; however, Company “A’s” largest customer is 15% of their total sales and Company “B’s” largest customer is 95% of their total sales – do you think this might affect value? ….. More than likely! Do you think the each deal might be structured differently? Very possible. In fact, when comparing these two companies, customer saturation could actually be the difference between making a very quick sale – or not selling the business at all.
There are several methods used to determine the value of a business. Some will argue that a business valuation is a subjective process – which is many times true (“Do I use a 2 times multiple, or a 4 times multiple?”). Because of this, it is recommended that you use multiple methods and then compare the findings – if 4 different methods keep coming up with similar numbers, you know that your value is in the ballpark. Some methods that are commonly used include:
– Income Capitalization: Future income is calculated based upon historical data and a variety of assumptions.
– Income Multiple: The net income (profit/owner’s benefit/seller’s cash flow) of a business is subject to a certain multiple to arrive at a selling price.
– Asset Valuations: Calculates the value of all of the assets of a business and arrives at the appropriate price.
– Liquidation Value: Determines the value of the company’s assets if it were forced to sell all of them in a short period of time (usually less than 12 months).
– Rules Of Thumb: The selling price of other “like” businesses is used as a multiple of cash flow or a percentage of revenue.
In order to lesson the tax burden, many business owners will show a smaller net profit. So, during a cash-flow analysis, you will oftentimes find numerous expenses (Depreciation, interest, excessive officer salaries, personal expenses …etc.) that you can add back to the bottom line – which will, in turn, help strengthen the value of the business.
As mentioned above, one way to calculate value is to use a multiple of the business’ cash-flow. But, how do you determine the multiple? 2 times? 4 times? This is where things can be viewed as somewhat subjective because the ideal multiplier will oftentimes be determined by the level of expectations of the seller/buyer. For example, one buyer might be content with a 10% return on a well-established/”safe” investment – yet, another buyer might not accept anything below a 25% return on their investment because of a potentially high risk factor. Including the inventory in the sales price versus adding it to the sales price can also affect the multiplier as well.