Calculating the worth of a small business can be accomplished in several ways. These include valuing based on its financial strength, sales/earnings projections, or comparison to similar businesses. Let’s take a look…
Cash Flow Valuation
This valuation takes a period of time during which there is a positive and recurring cash flow. From this cash flow a capitalization rate or the business’s expected rate-of-return is calculated. This is the rate of return a buyer would expect to earn on the purchase price of the company.
For small businesses this rate is usually in the 20-25% range. Which means that the purchaser would expect to get back her entire investment in 4-5 years.
Discounted Cash Flow Valuation
This valuation calculation uses the business’s projected future cash flow and time value of money to determine the current value. While the calculation can be complex there are online valuation calculators that will assist.
With this method the business’s current value is determined by comparing the recent sale prices of similar businesses. Finding relevant comparisons can be difficult but look at several ‘similar’ businesses. Online databases are available to find comps which can then be adjusted.
Seller’s Earnings Valuation
This calculation is determined on how much money (cash) it takes to run the business excluding owner’s salary, benefits, and other non-essential expenses.
Reasons to Evaluate a Small Business
- Want to sell the business
- Trying to attract investors
- Buying out other owners/partners
- Offering employees equity
- Personal event, such as: death, marriage, divorce
- Applying for a loan or line of credit
- Analyzing the business
You can perform an evaluation on your own or by hiring a professional business appraiser or business expert (banker, venture investor, CPA). Either way, here’s what you are going to need:
At a minimum you will need three to five years of tax returns and financial statements. Including balance sheets, profit and loss statements, cash flow statements.
Other Essential Documents
Copies of business licenses, permits, and deeds. Ongoing contracts, insurance policies, vendors and dealership information, client list, any loan information and credit reports.
Listing of Intangibles
Copyrights, patents, and goodwill or brand equity worth. Email lists, membership rosters, domain names, social profiles, unique processes and systems.
Prepare a SWOT analysis to show the business’s strengths and weaknesses.
It is a good idea to value your business on a regular basis. This aids in tracking progress over time and uncovering growth opportunities. Calculating the worth of a small business is common and varied depending upon the reason for the valuation.
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