Valuing your business on a regular basis can give you the information required to increase profits for the short and long term. This concept is discussed in the book "Six Steps to Small Business Success" by R. Sean Manning. Small businesses are typically valued according to three main methods by banks, brokers and buyers.
1. Gross Sales Method This method is used mostly in the service industry. I have seen a range of .50 to 1.5 times gross sales. Example would be gross sales of $500,000 times .90 industry rate equals $450,000 value. Note .90 is used from some donut franchises.
2. Asset Valuation Method This method takes the fair market value of the assets, including intellectual property, multiplied by a range from .75 to 2.00 less the liabilities. A retail store could be valued at assets 100,000 X 1.00 less liabilities of $40,000 yielding a valuation of $60,000.
3. Net Adjusted Profits This method is favored by bankers and professionals because it demonstrates that the company has the ability to pay the acquisition debt back within a reasonable amount of time, usually 3-7 years. The formula is EBIDA (earnings before interest, depreciation and amortization) adjusted for reasonable owner and family member salaries and benefits. The formula usually averages the last 3-5 years of profits. Any changes planned by the buyer to increase any of the above is usually not factored into the above calculations, except Intellectual property, limited licenses issued or special locations etc.
We will continue to write about these concepts in future issues. Please call us anytime, Manning & Company PC, 303-761-9119 with questions and feel free to pass this along to a friend.
The book "Six Steps to Small Business Success" by Co-Author R Sean Manning, CPA is available on Amazon.com.