In order to determine the value of a business we need to determine 2 things: what a business owns and what it earns.
What a Business Owns
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 a Business Earns
What a business earns 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
Owner operated businesses with sales of $1 million or less generally sell for the value of the assets, 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. Businesses with sales of $1 million to $10 million may sell for straight earnings multiples of three to six. A thorough 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 or 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 broker will be able to decide what the most relevant information about a business is and then make an informed decision about its value.
If you are unclear about something try our glossary of terms.
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