When buying or selling a business, it all comes down to price. Is the offer fair? Does it overestimate the value of the company? Underestimate the value of the company? Now, of course, depending if you are buying or selling, there are different objectives for the desired price of the company. The most suitable option for both counterparts, however, to is come up with a fair price justified through hard calculations. The following four techniques can be extremely helpful when trying to determine the value of a company to either buy or sell.
1. Asset Approach
You can start by taking a look at the value of the business’s assets. A business can be considered “a sum of its parts,” meaning that adding together the value of the equipment, inventory and other things that the business owns can give an estimate for the overall value. All of this information can be accessed through the balance sheet of the company, which is necessary to calculate the value with this asset-based approach. Reviewing the balance sheet from a company you are interested in buying is also an opportunity to have insight into how the company is run by the current owners. If the company doesn’t have a good set of books, then you may want to think twice about buying it. Likewise, companies looking to sell need to make sure to get their books in order, assuming that potential buyers will want to see them before the deal goes through.
2. Sales or Earnings Multiple
With this technique, the business is no longer considered by the sum of the value of its assets, but rather the value of its current cash flows. According to the industry, there are standardized “multiples” that can be multiplied by data such as sales or earnings to find the value of the company. For example, businesses might have a multiple of “two times sales,” meaning that the value of the company would be $200,000 if it typically sells $100,000 per year. If the multiple were “one times sales,” the business would be sold for $100,000, the same amount as sales.
Although the sales multiple is a widely accepted valuation technique, the earnings multiple tends to be more accurate. It takes into account all of the expenses of the company, and determines the value based on the “leftover” money after all is said and done.
3. Market Approach
This method determines the value of a company by comparing it to other companies for sale or soon to be for sale in the same industry, of the same size or located within the same geographical area. While it can be helpful to compare your business to similar listings, this technique tends to be subjective. Estimating the size of the opportunity, market conditions, goodwill, customer base and staff can be biased and prove difficult to getting a realistic value estimation.
4. Discounted Cash-flow Analysis
The cash-flow analysis is a technique used by Warren Buffet when he decides to buy a new business. The goal is to gather information about how much cash the company has generated over the past few years and project, based on market trends, how much money it can expect to generate in the coming years. These future projections are then “discounted” using the interest rate of the long-term Treasury bill to find the current value of those projections. By adding together the current value of those future cash flows, you can determine an estimate for the sales price of the company.
Aside from the results of these calculations, there are nonfinancial considerations to take into account as well. Even though the purchase price may be higher than another option, the location of one shop could be superior. Or, perhaps, you have always wanted to own this type of business, and it would be a dream come true for this purchase to go through. When buying or selling a business, try not to give as much weight to these nonfinancial assets in the valuation process. As highly subjective variables, they can blur the true value that you previously calculated.
At the end of the day, it is worth the time and effort to perform each of the four methods outlined above. If you are selling, choose the highest price and, if you are buying, choose the lowest price to place your offer. By performing all of the analyses, you are better suited with knowledge about a reasonable range of sales prices.
With these tools, you should be fully equipped to value the business you have in mind!
Author: Deanna Ayres is the SEM Strategist and Community Outreach Supervisor at The Marketing Zen Group & allcapcorp.com. She loves to come up with new content strategies for and with her team and believes that connecting on a personal level is vital to success. Growing up in Europe has allowed her a unique insight into cultural differences in business & marketing. In her spare time she is a photographer, hobby cook with a love for coffee, gamer and geek. Follow her @deanna_ayres
Published: December 17, 2014