Most Common Business Valuation Methods Used

As a Business Broker one of the most common questions I receive from small business owners and entrepreneurs I meet is this the following: How do I get a quick idea what my business might be worth? More often that not, most of these individuals are just looking for a rough “street valuation” to determine if they should sell now or sometime in the future. Although there are many unique factors to consider when valuing any individual business, and there are generally no definitive or concrete rules on what any particular existing business maybe worth at any given time, below are a few widely used and common quick business valuation methods that should give most small business owners an adequate starting point to help determine what their business might be worth in today’s market place.

Multiple of Seller’s Adjusted Net Cash Flow:

The most widely used method to value and determine an asking price for a small business is based on the adjustment or recasting of a business's most recent annual profit and loss statement. The goal in this process is to determine the true earning power of the business by adding back to the net profit all the non-essential or discretionary expenses not necessary to run the business to demonstrate a more realistic net cash flow for the owner.

Once this number is determined, the next step is to multiply it by a business category related multiple (service, retail, manufacturing, etc) that are widely used as rules of thumb by the business valuation and business brokerage community. For instance, in general terms small service related businesses are generally valued at a multiple of somewhere 2 to 2.5 times the Sellers annual adjusted net cash flow. Small manufacturing businesses generally receive higher multiples that can be in the 3 to 3.5 times range.

There are a variety of resources available to the public to find and research cash flow multiples that may be relevant or specific to your business. This includes well known guides such as the Business Reference Guide by Tom West, and business for sale directories such as BizBuySell.com that provide a data base of recent business sales and the multiples achieved. You may also want to visit fastbusinessvaluations.com which provides a free online business valuation calculator based on widely used industry related valuation multiples.

I would also recommend if you are considering selling your business to contact a local professional business broker in your area. He or she may be able to provide you with valuable information about recent sales in your market of similar businesses like yours, and the net cash flow multiple that they eventually sold at. You can find small business brokers in your area by visiting a directory like findabusinessbroker.com

Industry Rules Of Thumb:

Another commonly used quick business valuation method is to use a general rule of thumb. A rule of thumb valuation basically consists of using a simple formula that estimates the value of a business through a set of established and very general business pricing guidelines.

For example:
Auto Repair Shop: 35% of annual revenues
Full Service Gas Station: 2 to 3 times Sellers Adjusted net
Fast Food Business: 40% of annual revenues
Janitorial Service: 2 times Sellers Adjusted net
Motels: $20,000 per room

Keep in mind like all quick valuation methods “rules of thumb” are subject to the various unique characteristics of each target business being valued. Reference books like the aforementioned “Business Reference Guide” offer a comprehensive and excellent database of “rules of thumb’ by individual business category.

Market Comparables:

With the advent of the Internet, business owners now have the ability in most cases to view dozens (sometimes more) of real time listings of businesses very similar to their own on large online “business for sale” directories. Although it’s been my observation that many of these small businesses listed for sale tend to be overpriced, these directories such as bizbuysell.com still can provide a very useful source of free raw data, including rough comparables of both “for sale” and “sold” business listings. Keep in mind also that very few businesses will ultimately sell at there listed asking price, but if priced properly, (and the price can be supported with good financial records) many should ultimately sell with in 80% of their asking price.

Liquidation Value:

This is a relatively simple and fast way to value a small business by determining what the sale or liquidation of all the businesses’ hard assets (equipment, inventory, receivables) would generate in total proceeds on the open market after paying off any liabilities or debt associated with the business. Although a business liquidation valuation is a relatively straight for ward process, it does have significant draw backs as a valuation method because it does not take in to account the value of important factors such as goodwill, established customer/client base, future growth potential, and more.

Summary:

Keep in mind that even though all these valuation methods above offer either a quick and inexpensive way to get a rough idea of the value of most small businesses, or can be used as pricing guidelines when selling a business, at the end of the day a business is worth what some else is willing to pay for it.