What Is My Business Worth?
Determining the value of a business is often a complex task and is best done by either a VR professional business intermediary or a qualified business valuation analyst.
Before one can determine the market value of a business, the financial information (profit and loss statement and tax returns) usually has to be recast to reflect the true earning power of a privately held business.
The recasting of financial statements provides buyers with a common baseline, Discretionary Earnings (DE), to compare earnings from different businesses and calculate the potential earnings after acquisition.
Discretionary Earnings or DE is a measure of the total financial benefit accruing to the owner of a business.
There are several methods for pricing a business
- Cash Flow Method – multiple of the annual Discretionary Earnings. This multiple can vary widely depending on the business, the economy and the industry trend.
- Asset Method – A combination of Furniture, Fixtures and Equipment (FF&E), the inventory and a multiple of Discretionary Earnings (DE).
- Gross Sales Method – 3 to 12 month gross sales; again depending on the business, the economy and the industry trend.
- Comparable Sales/Market Method – This method compares sales of similar businesses and also the valuation multiples from these acquisitions. An adequate number of comparable companies are necessary to produce credible results.
We prefer to use the Comparable Sales/Market Method whenever we have a sufficient number of comparables to be statistically reliable. We use the ratios of the selling price to the discretionary earnings and the selling price to gross revenues and weigh the two valuations we derive. In this way, we make use of both the cash flow and gross sales methods and base the valuation on actual transactions.
Price is usually related to cash flow and varies with the financing terms agreed upon. Price will also depend on the type of business, the value of the assets, general attractiveness of the business and future potential, among other factors. True market value is what a buyer agrees to pay and a seller agrees to accept (without undue pressure).