Essentials To Accurately Valuing Your Small Business

Understanding the value of your small business is especially important if there is interest from another individual who may be looking to purchase or buy your existing small business. 

First off, congratulations are in order. Second, before celebrating too keenly, keep in mind that valuing a small business can be challenging, but not impossible. Before you pop the champagne, you have some work to do.

Here’s what you need to know if you want to appropriately gauge the value of a small business.

Ask the tough questions

What matters most when determining the value of a business? Is it the status of the books? How many clients frequent the business per year? The expected growth? In the end, determining the value of a small business is not something that comes with exact science.

For each business out there, the formula to determine the value of the business could be different. Since there can be a variety of ways to determine what the business is worth, consider valuation to be more of an art than a science.

Making an estimation that reflects the true value can come with a certain number of criteria.

Use the Multiple of Earnings method

The Multiple of Earnings method is a common way to make a value statement for your small business. First, you will need to determine the cash flow of your business. Before looking at Multiple of Earnings methodologies, you will want to first determine if you are considering pre-tax earnings or after-tax earnings. Some will argue that pre-tax earnings aren’t technically earnings at all, but you can use either of these figures.

A small, personal service business may be valued at a multiple of one times the current profits, while an extremely well-established business with a current market position that won’t change any time soon (or have the foreseeable impact of any major competition) may have a multiple of 8 to 10 times current profits. To make sense of how much your business is worth, there are also multiples between these two ends of the spectrum.

Using Multiple of Earnings makes sense if own a small to mid-sized small business, but if your sales bring in close to several million to several hundred million dollars per year, you may want to think of valuation in terms of a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization).

If your business falls into this type of category, a common and fair valuation range is five to seven times EBITDA.

Comparables (i.e. “Let’s see what the competition sold at...”)

Another common valuation method is to research at what price a comparable company to yours was sold at. What was the purchasing value? Monitoring trends, conducting research, and asking around at annual conferences within your industry can help you gather the data you may need. One risk with using a comparable method is that you may be assuming a likeness between your business and another, but in reality, there could be stark differences.

Don’t forget yourself: What do you think your business is worth?

Pricing first begins by keeping your own subjective considerations in mind. If this type of experience has you shaking in your boots as a small business owner, know that there are professionals out there who can guide you. While these professionals aren’t entirely necessary, keep your own temperament and character in mind. How useful would a guide be for you in this process?

Taking inventory: Evaluate your business assets

Within the small business you are in charge of, what is the total amount of the assets you have on board? What does your business own? Is there a laundry list of equipment that can add to and help increase the value of the business? What type of inventory could also contribute to this sum figure? Include furnishings and fixtures, too.

The worth of these assets is important for two reasons. For one, these items are certainly included in the value of your business, because if you didn’t have these available, whoever is looking to buy your business would have to purchase items like these if they were to start the business from scratch.

Second, when you calculate the sum total of the assets you already have on board with your business, you may find that liquidation could be more expedient in recovering the value from your original business investment. Before you make a hard decision to sell, consider the potential here too.

Understanding your financial footing

In a previous post, small business accounting and bookkeeping was a focus. Do you feel that within your small business you have a strong financial foothold?

Ask yourself this: where do you stand in relation to the current status of the books in your small business? Having an adequate handle on the financial state of your business will certainly play into how the company is valued. Is your business profitable? Or isn’t it?

Try this: Assemble the financial reports and records for business this year and records from the past three years (if you have been in business for all those years). Prepare income statements, cash flow statements, balance sheets, and the seller’s discretionary earnings statements.

These will all help contribute to making an estimation when it comes to the value of your business. Working with your accountant can be especially helpful in learning how to read forms you may otherwise be unfamiliar with.

Keep market conditions in mind

Because business unfolded a certain way last year, do not expect business to continue on without any erratic behavior. Predictability may be a factor on the table during a possible valuation experience, but expect there to be wiggle room here. No one can be 100 percent certain of future projections.

Throughout the years, predictability will be a difficult factor to maintain. No matter how fast a company grows and maintains their momentum, the future will certainly be unsure. Taking future predictions into account could leave space for certain subjective discounts within the transaction. Everyone may have their own point of view on this topic. 

For other business advice, call 844-55-FLUID or schedule a free consultation with a business specialists at Fluid Capital, individuals who are always available to help you wade through the world of small business.