How much is a business worth?
Either you are looking to buy a business or you are interested in selling your own business. These methods will give you the basic fundamentals on how to evaluate what a business is worth. Depending on the size of the business you are evaluating may determine how in depth you will need to analyze the business and the method to use.
Start by taking a look at what the business owns. This can include equipment, product inventory, amount of clients, real estate etc. If you were starting the business from scratch these are some of the things you would need to buy, so knowing at least the replacement cost is a good start. Taking a look at the balance sheets will also give you an idea of the value of the assets. If the previous owner or yourself did not manage the books very well then it will be very difficult to get an accurate value which can leave you in a serious bind if you are buying.
What is revenue? Revenue is the amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the top line or gross income figure from which costs are subtracted to determine net income.
In short, Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold. This is also known as sales on an income statement.
But remember, revenue does not always mean that the business is cash flow positive. So how does this help with evaluating what a business is worth? Knowing what kind of cash stream is coming in each year is a must, but how do you know if the business is making a profit? If the revenue from your products and services is covering your expenses, you’re turning a profit. That’s the short answer, but you may need to dig deeper and look at things like net profit margin and gross profit margin.
Once you have a good understanding of what kind of revenue stream the business has and whether it is profitable or not, will help to evaluate what the business is worth.
This method is used to calculate how you are estimating the marketplace to perform which will be computed, along with with the cash flow, to give a rough value. In some industries, it is common to see a business sell for a multiple of two or three times annual adjusted net income. A lower multiple can mean a lower market demand, as in not very many people won’t buy that type of business.
So for example, Let us say that a manufacturing company has a multiple of four being it is in much more demand of buyers wanting to buy. The business providing an adjusted net profit of $300,000 might sell in the range of $1,200,000. But remember that a seller must be able to provide the company’s earnings history with financial reports and tax returns before the higher price will be offered.
This video will briefly explain the multiple method and valuation