In a past article, we talked about “How Much is Your Business Worth,” and the art and science of business valuation. A business broker will use a number of analytic methods. The valuation analysis is crucial, yet coming up with a price to place on the business may be the most important step. Sellers need to set a price that will attract interest and buyers need to know if that price is fair and will allow them to support themselves and pay for the business if they are to purchase it. The primary way a buyer judges a target business is by the numbers. The seller’s financial reports must be accurate, credible and meet professional standards. Buyers will use financial facts from the past to determine financial hopes of the future.
What Does a Seller Have To Sell?
It is important to remember that a business really has only three things to sell: 1) tangible assets, 2) the potential of those assets to produce earnings and 3) goodwill. Goodwill is the intangible value of being in business.
Three Approaches to Value
As a business broker, we use valuation methods to quantify the very inexact science of valuing a business.
- Market Comparison
This approach deals with the fair market value of the business. This is the price a similarly sized company in a similar industry may sell for when a willing seller meets a willing and able buyer. But no two businesses are alike, which, unlike most residential real estate, makes accurate comparisons difficult.
- Ratio Multiplier
Each industry has a formula that can be applied. These multipliers consider gross sales and not profits.
- Owner’s Cash Flow
How much money does the business make?
Owner’s Cash Flow
When we evaluate a business we look at the key elements for our valuation but most importantly we will complete an Owner’s Cash Flow analysis. Unless the business value is based on proprietary intellectual property, like a technology company, for example, all small to medium size businesses will sell for a multiple of Owner’s Cash Flow. Owner’s Cash Flow is calculated by adding owner’s salary, owner’s payroll taxes, health benefits, retirement benefits, financials perks, depreciation, amortization and non-reoccurring expenses to the net income stated on the profit and loss statements and tax returns (a bank will base its valuation of your business on tax returns). By adding these adjustment items back to the financial statement, a buyer will have a better idea of how much income he or she can expect to receive if he or she purchases the company.
Key Elements for Valuing a Business
- Owner’s Cash Flow
- Value of Tangible Assets
- Equipment – the current market value of the equipment
- Inventory – the average on-hand or usual working amount at cost
- Value of Intangible Assets
- Management Team in Place
- Customer Concentration
- Comparable Sales
- Replacement Value of Equipment Adjustment
- Full-time Owner Adjustment
- Market Lease Adjustment
- Market Segment
- Territory/Franchise/Distribution Rights
- Documents Systems
- Current Business Environment – locally and for your industry
Business owners should understand the value of their business at all times. Selling a business can be an overwhelming task but when you use an experienced business broker, we will guide you each step of the way and help with advance planning, which will result in your ability to cash out with the ultimate price you deserve. QCBN
By Matt Uhler
Matt Uhler is a business broker with WCI BROKERS. WCI BROKERS believes that as dedicated business transition professionals they can help make a difference in the lives of their clients. Whether it’s our buyers or sellers, we’ve been an integral part of the change they were seeking in their life.
Call Matt Uhler at 928-445-1144 to schedule a complementary “snapshot” business valuation.