Business 101 question
Let me start by stating I did not go to school for business, nor do I have a business degree.
With that said, what is the typical rule when it comes to assessing a value of a business?
For instance, is the value of a business based on weekly gross sales or weekly net profit?
At what percentage of that figure?
I've been told in my business (wholesale meat making a very small margin compared to anything retail) the value is figured at 16X the weekly gross sales.
(example, a business that has $10K gross sales per week is valued at $160K.)
Make any sense?
Jersey Dave, I'm a CPA near Indianapolis Indiana.
Valuing a business varies depending on the industry, however, there are definitely a couple of basics to consider when assigning a "price".
In my specific industry, Tax & Accounting businesses are typically valued at GROSS INCOME for 1 year. (plus some other costs which I will explain)
With any business and any industry, there's always a "goodwill" factor that plays into the cost. Think of goodwill as a premium on the purchase price which depends upon: Reputation, Name, Internal Processes, etc.
For instance, a business that has existed for 30 years versus a business that begin a year ago will cost more to purchase even if both of those businesses have identical annual profits.
I Hope this helps a little bit. FYI, there is an actual designation and/or license that some individuals obtain to perform official "business valuations". I'm pretty sure they are just referred to as Business Valuation Experts. I would recommend ANYONE selling an established business to hire one of these experts. Sure it may cost some money to hire this person, but think about what's at stake.
Yes, as ASW mentioned above, there are alot of angles to look at when valuing a business.
Gross Margin and Net Income are hot items (but definitely NOT the only items) to look at but like mentioned above, other things that the business has such as customer relationships, computer and software technology developed in house, etc. lead to goodwill.
The aging of the accounts receivable, amount of debt on the balance sheet as well as historical financial data help to determine a business value.
I was in public accounting for 10 years and am a senior manage of finance for a major logistics company where we have purchased 5 companies since 2002.
There are accounting firms such as E&Y who have specialized teams that perform business valuation services.
You need a business appraisal.
Should cost you no more than $1500.
You can take several approaches:
1) you can do a build or buy analysis. This is basically comparing the net value of the balance sheet to what it would cost to recreate the assets of the business. This measure gives you a look at the current tangible value, but does not capture the value of customer and supplier relationships or future growth opportunities.
2) in most industries there is generally a standard multiple of sales. Generally speaking, this measure is highly dependent upon the capital intensiveness of the industry. This measure gives you a good "rule of thumb" starting point to come up with a valuation.
3) Price earnings ratio. What multiple of earnings are you paying? This is a key metric. A good way to look at a business valuation is to invert this ratio to get an earnings yield. For example, if you are paying $100 for $10 in earnings. You are getting a 10% earnings yield on your money. Pay $50 and you are getting 20%. Interestingly many private businesses trade at around 5 times earnings, giving you a 20% earnings yield.
Finally, there is Net Present Value. The correct value of any business is the present value of the future free cash flows discounted to a present value by the appropriate risk adjusts rate.
The problem with this measure is that it involves a lot of estimating. Estimating future sales, future margins and future interest rates.
In the end, the market says the price that a business will sell for. Do all of the above, but make sure you know the going rate on recent sales in the industry. There is good price and a bad price to pay for any business.
The best measure of a business is cash flow since in the end thats what youll care about - is my savings account getting bigger. Many small businesses aren't capital intensive and don't have much depreciation and amortization, so net income usually tracks closely to cash flow.
Don't forget to look at asset depletion, however. For instance, you could look at a small business that has been generating good cash flow for 2-3 years in a row and get excited, but this may not mean they are worth much if they have been doing that by not reinvesting in their business so equipment, tooling, computers, etc. are running down and will need to be replaced. Their cash flow may appear high because they have a bow wave of building investment needs.
As for valuation, theoretically if you had a good cash flow model you could value it without knowing much about the industry. As for "multiples" or similar rules of thumb, they exist but you have to know how to apply them. For instance a business generating 100K annual cash flow is worth much more if it has good growth prospects than if it has poor growth prospects. It's also worth much more if the cash flow is fairly predictable and safe rather than highly cyclical (e.g., in the last downturn, did grocery stores or boat dealers get hit worse?).
There's a lot too it. If the answer is important to you, having an accountant or business appraiser come in and look would be well worth the money.
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