Thinking of purchasing a company or selling your business? Diving into a new business venture is a scary proposition even if this isn’t your first go it. From starting your own business to acquiring an already established company, one of the hardest aspects of making that jump is assessing the worth of the business. Pay too much and you could wait years for a profit. Sell for too little, and you sell your own financial future short.
While it’s always best to enlist professional help to conduct a business valuation, here are some ways to estimate it.
To determine the value of a business, consider the industry. If the industry is lagging or facing a downturn, the value of the business, regardless of its assets or revenue, will take a hit. Conversely, if the industry has been experiencing faster than average growth, the price of the business will reflect this. Industry growth equals potential success. So study the health of the industry.
Look into the books of a business to determine the worth of its assets. Consider:
- Equipment, with consideration for maintenance costs and depreciation
- Land and buildings, with consideration for real estate projections
- Taxes and liens
- Outstanding debts
What client lists or established accounts come with the company? Are the client’s one time purchasers of the product, or do they come back regularly for a service? Estimate the projected income from these. Measure against the cost of attracting new business. Place a value on the lifetime worth of each client. Also evaluate the worth of each name on your email list, each Facebook follower, and each blog subscriber. Each one represents potential revenue.
Licenses, Permits, and Warranties
Look at what licenses and permits have already been paid for. Some equipment comes with a warranty. Check how long these last before expiring and the cost of renewal. Some things can be transferred from one business owner to another. Some cannot.
Inspections and Appraisals
Checks and balances like these protect both the buyer and the seller. Get inspections for any property or equipment. Appraisals are done on various purchases and trades, from homes to cars, electronics to collectibles. The same is done for business assets. Ultimately, a business is worth what you are willing to pay for it. But be sure to research accurate valuations on a company to determine if what you’re willing to pay is a fair price or not.
Revenue, of course, plays a role in determining a company’s worth. But what if they made a ton of revenue but never turned a profit? CNN mentions Uber and Amazon as examples where a business invested heavily up front and has yet to break even. Ask yourself whether you are willing to invest in something that doesn’t look great on paper because the industry is growing. A trusted financial advisor can advise you on the risks.
Even if a company generates income, it may not mean it’s enough to purchase it and see a profit. And if those sales are actual profits, you need to be sure you aren’t paying too much for them up front.
Try the Discounted Cash Flow Analysis method. Review how much cash the company has made in the last year, and calculate the actual value of that money coming in. For a rough idea, try this calculator from Bankrate. You can’t assume that there will always be cash flow coming into a business. However, this method provides perspective on its potential value.
As you can see, there are multiple ways to determine the total value of purchasing or selling a business. Like any major transaction, it requires research and due diligence from all the parties involved in the acquisition. A little bit of homework, a little gut instinct, and a whole lot of number crunching will provide clarity in a sometimes daunting task.
While we aim to provide insight and thought to this sometimes complicated subject, we want to remind you that only a qualified professional can handle an official business valuation. Contact us if we can help.