5 Items That You Should Factor into Your Business Valuation

Use fact-based and not emotion-based data.

So, you’ve decided it’s time to sell your business. You’ve spent the time mulling over the decision, talking it out with your family and getting input from your trusted friends, mentors and other industry professionals.

Coming to the conclusion that you want to sell your business is the first step in what will be a multi-step process. Step two may be the most complicated and, at the same time, sensitive topic to you: Figuring out how much your business is worth.

Business owners will often have a number in mind when they make the decision to sell their business. That number could be based on a number of factors, including:

• How much time, effort and money they’ve invested into the business over the years
• How much money they want, or need, to make the business worth selling
• How much they feel the business could be worth one day

The challenge that a lot of business owners face when they decide they want to sell their business is they come up with the value of their business in emotional, instead of scientific, ways. How much you’ve put into the business, how much you want from the sale and how much you feel it could be worth are all emotionally tied to you – not the potential buyer.

Much like a home, a potential buyer will look at how much he or she will have to invest in not only buying the business but in making it their own. And to come up with an appropriate value on your business, potential buyers won’t care about any of your emotional attachments to it. Instead, they will be looking for cold, hard facts that support the valuation.

So, how do you determine a true, independent valuation of your company? Here are five of the most important factors that will go into determining that number.

1. How Much Your Assets are Worth

The first step in coming up with a value for your business is to add up the value of all the assets the business has. This includes any inventory or equipment you own, minus any debts or liabilities the business has that the new owner will have to assume.

This calculation will provide you with a net asset value. This is only a starting point for the valuation, though, as your business is certainly worth more than the things it owns.

2. How Much Revenue Your Business Earns

This is the area where a lot of people will turn to first, and for obvious reasons. The money your business brings in is a good determining factor for how much it is worth today, and how much it could be worth tomorrow.

To figure this part out, you’ll want to calculate how much your business earns in annual sales. Once you do that, you’ll want to consult with a business broker who should be able to tell you how much a business in your industry might be worth based on revenue.

For example, a business in your industry might be worth two-and-a-half times its sales numbers. In this hypothetical, if your business’ annual sales are $1.5 million, it might be worth $3.75 million.

3. How Much Your Business’ Earnings Multiples Are

Valuing your business based on your earnings multiples may be a better way to appropriately value your business, because it takes into account not just what your business is doing now, but what it may be projected to do in the near future.

In this case, you’ll need to calculate the earnings of your company, or its price-to-earnings ratio. You would then take this ratio and multiply it by your company’s earnings.

For example, if the typical price-to-earnings ratio in your industry is 12, and your company’s projected earnings for the next few years are $350,000, then your business’ value based on this calculation would be $4.2 million.

4. How Much Cash Flow Your Business Has

Earnings is an entirely separate category to cash flow, even though they both obviously have to do with money. Earnings are what your business sells; cash flow, conversely, is how much money actually comes in on receipts and when it does so. A company may have impressive earnings but poor cash flow because it doesn’t have a great collection rate, for example, or collections lag considerably behind when the sales occur.

Figuring out what your cash flow value is, or rather what your Net Present Value (NPV) is, can be a little complicated. However, there are plenty of free online resources the can help you determine your NPV. Basically, what this calculation does is project your cash flow and then discount that based on what your cash flow is today.

For this example, let’s assume the initial investment in the business is $1 million, and the discount rate is 5%. If your cash flow in year one is $250,000 and it increases by $25,000 over the next four years, your Net Present Value would be $1.19 million.

5. How Other Factors Affect Your Business Value

The last general thing you want to keep in mind is how other items should factor into your business valuation. One of the biggest items in this arena is your business location. Are businesses in your industry a hot commodity in your location? Do they perform above the industry average or below it in your region?

Again, like real estate, it’s all about location, location, location.

By taking these five things into consideration, you’ll be able to better determine your business value when you go to sell it to someone else.

Sunbelt Business Brokers of West Palm Beach can help you prepare to sell your business in South Florida, guiding you from listing to closing.  If you’re considering selling your business, get in touch with us today for a confidential, no obligation conversation.