The value of a business is based on two things: what it owns and what it earns.
What It Owns
A business has tangible and intangible assets. The tangible assets are the furniture, fixtures, equipment, inventory, and real estate. The intangible assets can include the trade name, contracts, leases, client lists, licenses, recipes, and patents.
What It Earns
A business provides a certain financial benefit to the owner. The benefit generally comes in the form of business profits and a salary to the owner. It can also provide the owner with fringe benefits such as health insurance, a company car, or a retirement plan.
How Value is Calculated
There are different methods used to determine the value of a business. Some methods are straightforward, others very complex. For simplicity sake, we list some of the more straightforward methods used:
* Business Value is based on the value of the assets of the business, or the assets of the business plus one to three times the earnings. If the earnings are stable and growing, the value is on the higher end. If the earnings are variable or declining, the value is on the lower end. This method is more commonly used on owner-operated businesses with sales on the lower end of the spectrum.
* Businesses with sales of $1 million to $10 million may sell for straight earnings multiples of three to six. An investigation of the financial information is required to uncover the true earnings capability of the business. Again, if the earnings are stable and growing, a higher multiple is used. If the earnings are variable or declining, a lower multiple is used.
* Businesses with sales of more than $10 million often have specific industry criteria, which may be applied to determine the value. At this level, Buyers may be paying for market share, rights to patents and processes, additions to product lines, or the benefits of strategic or administrative consolidation.
Rules of Thumb
Most industries have one of more rules or thumb. However, they can vary widely and in most cases do not give an accurate value of a business. Since each business is unique, a particular rule of thumb can be off by as much as 100% or more. The business valuator will be able to decide what is the most relevant information about a business and then make an informed decision about its value.
The Value of a Business Valuator
Business valuation is as much an art as a science. While a business valuator does employ standardized formulas and methods to calculate value, it is most effective to work from assumptions that are based on his experience in the market place and his familiarity with the similar businesses. This process includes the selection of the most appropriate risk and return variables. In this way, the applied expertise leads to the best calculations of value for a specific business.
For more information, or for a free consultation to determine the value of your business, contact us today.