How to Value a Small Business

A small business valuation represents the total value of a company based on business assets, revenue, industry, liabilities and losses. Doing a valuation is an excellent opportunity to evaluate the financial situation and potential of your company or enterprise. Business you wish to purchase.

Whether you're planning on selling your business or have already received an offer, knowing how to value your business can help you develop a roadmap for your company and a future exit strategy. Entrepreneurs looking to buy an existing business should also become familiar with valuations and feel comfortable estimating value independent of the business owner's or broker's asking price.

There are a few key steps to valuing your business: In addition to doing your own research, consider consulting an expert.

Unless you’re a natural business and numbers whiz (or an accountant), valuing your business is not a simple process. First, you need to understand some important definitions.

Seller's Discretionary Earnings (SDE) represents the total financial value that a single owner receives from owning a business on an annual basis. Also known as adjusted cash flow, total owner's earnings, seller's discretionary cash flow, or recalculated earnings, the calculation includes income reported to the IRS and expenses such as non-cash expenses. It essentially represents the revenue that a business actually generates.

The SDE multiple values ​​a business according to industry standards. Different industries have different multiples. SDE multiples vary depending on market volatility, where the business is located, the size of the company, assets, and the degree of risk involved in the transfer of ownership.

Obviously, the higher the SDE multiple, the more valuable the business is. If you use EBITDA to value your business, then you would use the EBITDA multiple.

To calculate your business's SDE:

Step 1: Find out your earnings before taxes and interest.

Step 2: Add non-business essential purchases like vehicles and travel that you report as business expenses. Employee outings, charitable donations, one-time purchases, and your own payroll can all be included in your SDE. (When presenting your valuation, buyers may ask about discretionary cash flow, so be prepared to include all major expenses and purchases in your valuation.)

Step 3: Subtract any current liabilities or future payments from your net income.

Step 4: Compare with the SDE multiple.

To ensure accurate calculations, buyers and sellers need to keep their financial records in order, which will also be important for the actual transfer of ownership.

Employers should prepare the following documents to facilitate the assessment process:

• Licenses, deeds, and any ownership documents.

• Income statement and Balance sheet For the past three years.

• A brief summary of your business or personal financial situation.

While buyers won't need all of these documents, they will still want to verify their financial situation. Sellers will likely want to check the credit report and basic financial profile of the person or business they're selling to.

In addition to financial records, the buyer business planIt helps with accurate revenue forecasts, projections of business growth and profits, important background information about your company, details of key services and products, and more. Business Typewhich Show them how you make money and show potential buyers how they can actually reach your customer base and generate revenue if they buy your company.

Assets and liabilities are key components of a company's overall value, so it's important for both buyers and sellers to know the details. A company asset is anything that adds value to a company, such as intellectual property, a production line, or a company car.

There are two types of assets, tangible and intangible, which are weighted differently when calculating a company's total value. Tangible assets are physical assets that are used in the normal operation of a business and depreciate over time. These include things like property, equipment, inventory, and cash on hand.

Intangible assets are assets that have value but cannot be seen or touched. They include patents, copyrights, trademarks, customer loyalty, reputation, intellectual property, etc. Intangible assets are also inseparable from the company itself.

Liabilities are generally any outstanding debts that reduce the overall value of a company. These include bills payable, accounts payable, etc. Business Loansaccrued expenses, unearned revenue, etc. Business owners often retain business liabilities and continue to pay off debts even after selling the business.

A deep understanding of industry trends can help both buyers and sellers reach an informed valuation that reflects a company's assets and the current market. Understanding your industry can help you:

• Determine the SDE multiple and valuation methodology to be used.

• Evaluate market share and growth potential.

• See what similar businesses are selling for.

There are several methodologies for business valuation. Each method uses different aspects or variables of the business, such as the business's revenue, assets, or market data of similar companies, to calculate a numerical value. The final valuation should be the result of a consistent calculation, not a combination of different formulas or approaches.

The revenue approach to valuing a business involves determining how much revenue a business is expected to generate in the future. When using the revenue approach, there are two commonly used valuation methodologies to choose from:

• Discounted Cash Flow MethodThis method determines the future present value of a company Cash flowThe cash flow projections for a business are adjusted (or discounted) for the risk involved in purchasing the business. This approach is best for new businesses that have high growth potential but are not yet profitable.

• How to capitalize revenueThe earnings capitalization method also calculates a company's future profitability by considering the company's cash flows, annual rate of return (or return on investment), and expected value. However, while the discounted cash flow method takes into account more of a company's future financial fluctuations, the capitalization method assumes that a single period calculation will continue into the future. Therefore, established companies with stable profitability often use this valuation method.

Most online business valuation calculators use some version of the revenue approach. However, if you have more financial information on hand, you can try a more comprehensive business valuation tool that includes both profits and revenues, and assets and liabilities in the calculation.

Another common method is to value a company based solely on its assets. Specifically, the adjusted net worth method calculates the difference between a company's assets (such as equipment, real estate, inventory, and intangible assets) and its liabilities, with all of these assets adjusted to their fair market value. Asset valuation is also a great tool for internal use, helping you track expenses and capital resources.

To do an asset-based valuation, make a list of your assets and assign them a monetary value. For equipment and other depreciable assets, the value is usually somewhere between the selling price and the depreciated amount. A good rule of thumb is to estimate what the equipment would sell for today and use that number.

Because you know your company's equipment and production well, you can make a fairly accurate estimate of the value and depreciation of each asset. It gives you a rough idea of ​​the material value of your business without having to adjust the asset values ​​for the current market. This method is especially useful if your business holds primarily investments or real estate, is unprofitable, or is considering liquidation. In any case, a buyer will be interested in the individual value of your investments and equipment.