Making an accurate valuation of a company for sale is often the most challenging aspect of buying a business. In many instances, a buyer doesn’t have the same price in mind to what the business is worth compare to the seller. Most sellers can’t get over how much work they’ve poured into their businesses, which unfortunately, doesn’t get considered in the valuation. As a buyer, you have to remember that the asking price is not necessarily the same as the purchase price. You must come up with a valuation of a company formula that is accurate and that justifies that the investment is worth it.
Formula for valuing a business
There are several common ways to calculate the valuation of a company for acquisition, including the following.
Assets and liabilities valuation
While calculating the worth of the assets and liabilities may not provide a full valuation, it is an important factor in the buying decision. Every business has tangible and intangible assets as well as liabilities. Tangible assets include inventory, equipment, cash, and receivables. Intangible assets include the company name, logo, and trademarks; code exceptions and zoning variances; and other assets that offer value to that specific business. Liabilities include mortgages, loans, leases, payables, debt, and contracts.
Liquidation value
Determine the value of the company’s assets if it had to sell all of them within a short period of time. Typically this time period would be under one year.1
Income capitalization
The income capitalization formula converts a property’s income into an estimate of its value.2 It is based on historical data and a number of varying assumptions.
Income multiple
Multiply the yearly earnings, based on how long you believe that the company will be in operation, which is the multiplier of earnings.3 The income multiple is subjective and largely dependent on the confidence that the buyer has in his ability to reduce expenses, increase sales, and maintain the business far beyond recouping his initial investment.4
Rule of thumb
You use the selling price of a similar business as a percentage of revenue or multiple of cash flow. Simply take the total annual sales (minus sales taxes) and multiply it by the revenue percentage.5 While the rule of thumb may provide a very rough estimate of the value of a business, it is not generally used by professional, credentialed business valuation experts.
Consider all the Factors
In order to calculate a valuation of a company for acquisition, you need to factor in all of its assets, liabilities, recent revenue, and future potential as well as the abilities and skills that the buyer brings to the table. Are you planning to buy a business in order to make a profit from selling the assets? You’ll have to conduct a comprehensive evaluation and appraisal of both the tangible and intangible assets and decide if you’ll be able to decrease any liabilities via a negotiation with a creditor. If you liquidate a business, you may have to offer deep discounts that come with creditor concessions (i.e. early payment) to make the sale more quickly.6
Finally, keep in mind that a valuation is subjective with no scientific basis. Of course you want to consider the possible return on your investment. However, you should never invest in a business simply because the price is right. The business has to be worth it for you to bite the bullet., which means that the company itself has to be a good fit for you.7
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Veriti Consulting LLC provides certified business valuation services across the U.S. Learn more about our business services by calling 855.232.4410 or contact us via email.
1 https://www.bizbuysell.com/buyer_resources/how-to-value-a-business/06/
2 https://www.dummies.com/how-to/content/how-to-estimate-value-with-the-income-capitalizati.html
3 https://smallbusiness.chron.com/simple-formula-determine-value-business-69956.html
4 https://smallbusiness.chron.com/simple-formula-determine-value-business-69956.html
5 https://businessreferenceguide.com/about-the-data-in-brg/
6 https://smallbusiness.chron.com/simple-formula-determine-value-business-69956.html
7 https://www.bizbuysell.com/buyer_resources/how-to-value-a-business/06/
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