8 Tips on How to Value a Business

Valuing a business is a challenging aspect when buying a business.  How can you arrive at the right price for a business for sale?  Will you, the buyer, just rely on the asking price of the seller?  In most cases, the seller wants a price higher than the real price of the business because the former factors in the hard work and number of years he or she invested in the business.  It is up to you to decide if the price accurately reflects what the business is worth.  How will you arrive at a counter offer?  Here are some tips in valuing a business.

1.  You should learn how to read and understand income statements, balance sheets and other important financial records.  From the data reflected in these documents, you can follow the financial status of the business through the years.  These numbers can provide you with the basis in valuing the business.  Is the business growing?  Is it worth more now than last year or previous years?

2.  You can use the Asset Valuation method of valuing a business if you are buying a retail or a manufacturing business.  Calculate the fair market value of tangible assets such as equipment and inventory of the business, or the price to replace them.  If possible, use the replacement costs of the assets in the same or similar condition.  This method is usually used for companies losing money or with flat income.

3.  On the other hand, you take into account the intangible assets for service businesses such as professional services, consulting, or non-asset intensive companies.  Include in your consideration the number of years that the company has been in operation, the length of time the seller has owned the company, why the owner is selling the business, the location, profitability, level of competition, risk factors, growth potential, repeat customers, goodwill, etc. 

4.  You may also value the business based on the past historical data or performance of the company.  This can more or less predict the future profitability of the business.  But you also have to factor in the prevailing economic condition.  The price of the business usually increases during a growth period and drops when there is slow growth or a recession.

5.  You may also look at businesses for sale similar to what you are buying.  Your business valuation will be more accurate if you can find a business similar or close to the specifics of the business that you want to buy.

6.  You can use the Owner Benefit valuation or Income Approach if you are buying a business that has the ability to generate cash flow and profit.  The formula is: 

Owner Benefit or Discretionary Earnings X 0 – 3 = market value.

The Owner Benefit includes return of investment, living wage, debt service or interest expense, personal expenses, and depreciation of assets.  This amount is the money you can get based on what the company has generated in the past.

7.  Work with experts such as accountants, business brokers and appraisers.  An accountant can help you study the numbers of the business – its assets, liabilities, earnings and losses among other things.  Find a business broker or certified business appraiser who is experienced in valuing businesses similar to the one that you want to buy.

8.  Consider applying various valuation formulas to test the value you came up with.  Remember that valuation is a personal formula.  You could use one or combine various valuation methods to arrive at an average figure of what the business is worth to you.

Determining the value of a business is a complex procedure.  If you are new to this, it is best to seek the help of experts.  There are also software packages available that you may resort to save time or money.  The important thing is to gather all the numbers and information you need, and study them well. 

You may get the business of your dreams but it may cost you years of headache if you do not arrive at an accurate valuation.  Which valuation method is right for the business you want to buy?

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