Determining Business Value: Cash Is King, But……..
Many people believe that a multiple of earnings, or cash flow, is a static formula that applies to all businesses equally. This couldn’t be further from the truth. In fact, net income is only one of many factors that influence the value of a business. This article attempts to provide a broader, more accurate view of what influences the value of a business.
First, what’s the starting point? Step one is to determine the adjusted earnings, or cash flow, of a business. Note: the use of the term cash flow should not be confused with a company’s daily cash flow or statement of cash flow. The number you see as Cash Flow on our site, and other businesses for sale search engines, refers to adjusted cash flow or adjusted EBITDA. According to the IBBA (International Business Brokers Association) the standard formula for determining cash flow is:
EBITDA + one owner salary + one-time expenses + other owner benefits = Cash Flow
There are many models used in the business valuation process, some of which are very complex and not applicable to businesses with less than $5M in revenue. This article isn’t intended to be a tutorial on preparing a business valuation. The intention is to focus on Non-Financial Value Drivers, areas that influence a business value, either in a positive of negative direction. Below are some of the criteria we consider, and rate on a scale of 1-4:
- Earnings Track Record – have profits for the last 3+ years been consistent or somewhat lumpy
- Industry Growth – is the industry growing or declining
- Location – how much does the business’ location impact sales/customers
- Customer Concentrations – is there a broad customer base or do very few customers make up a high %
- Product/Service Concentration – are the firm’s revenues made up of many products/services or a few
- Market Concentration – does the business serve a large or limited geographical market
- Competition – are there many competitors in the market or few; large or small
- Employees – unskilled or highly skilled; long-term or short tenure; easy to replace or difficult
- Ease of Operation – is the business turnkey or are many processes in the owner’s head
- Management – owner operated with little or no management or is a strong management team in place
- Deal Financing – will lenders look favorably on the business for financing; will the business provide enough post-debt service cash to be attractive to prospective buyers
The bottom line in this analysis has to do with Transferability. A business that is positioned to, with reasonable ease to a qualified buyer, transfer clients and a stable workforce with policies and procedures in place, will a greater value and will be more attractive to the market.
Click here for a tool to assist in doing a self-evaluation of your business’ transferability.
If you would like to discuss your business value or how to reduce the gaps in any of these areas, please contact Sunbelt Business Advisors for a no-cost, no-obligation review session.