Even with the simplest small business valuation may seem an incredibly complex subject. But if the reason for carrying out the valuation is because you are selling your business, the valuation process should be quite simple.
Buyers are interested in buying from your company because of the profits. That’s why I always advocated the use of a multiple of earnings proven as the best way to come up with a value for your business and reach for your asking price.
However, even with this simple method, there are endless ways to vary the results: Use your past profits or expected future profits? Before or after taxes?
Come to think of it, how do you even define the word “profit”?
Does this mean the same as cash flow?
let us discuss all these questions.
But first I want to point out that the method described here is best for smaller companies (less than one million sales) where the owner also manages the company. Also, most of these do not apply to all new businesses or those that do not profit. For those types of businesses you have to use an asset-based valuation.
What profit do you use?
If you’re going to convince a buyer to choose your company over other companies in the market that they can buy, you must rely on her motives. Set your price based on your actual proven profit (as opposed to speculating on future earnings) makes the most sense to the buyer. It focuses directly its main concern – how much money the company actually makes
Now for the important question: How can the definition of “profit” !? we use cash flow? Or do we use something called EBIT (EBIT)?
The best, most logical number to base your valuation is “Advantage of the owner.” Accountant types like to take this “seller Discretionary Cash Flow” call
The formula for determining the benefit of the owner.
The annual profit before tax + owner’s Salary + Owner’s Perks / Benefits + interest + depreciation.
the number of the purchaser how much money the company is actually telling generate for you as the owner. Since interest and tax from the buyer payments other than yours will be, you want taxes and interest payments were in favor number of total ownership.
from there, the buyer can make their own estimates of what their interest and tax payments will be.
“Perks and benefits” to things like the car leasing, travel expenses, salaries for family members who are above the mark rate for the work they comprise perform. Each of the good things you get in addition to your salary that the company pays to be incorporated into the “Benefit of the owner.”
But the key concept here is that the benefit of the owner is the amount of money + other benefits it generates business for the owner. And since the prospect is buying the company to avoid getting money and benefits, benefit number of the owner is that any evaluation must begin.
I suggest you use an average of the last three years as owner benefit based on your appreciation.
If last year was a really good, you may be tempted to take advantage to use only the owner of the most recent year instead of the last three. I recommend you to use three years, because it gives more credibility to the buyer. Especially if your most recent year was significantly better than in previous years, the buyer may be a fluke or even worse -. Can they suspect that you have manipulated the numbers
If your earnings are trending for each of the last three years, you should consider the weight of the more recent years more heavily. For example, instead of adding and dividing maximum advantage of your own for the past three years by three, you can 70% to take you to the most recent year plus 20% of the previous year plus 10% of the previous year .