How Much is a Business Worth?

How Much Is a Business Worth? A Business Valuation Will Tell You

So you’ve finally found a business that interests you, it’s time for a business valuation. Remember a business is worth only whatever someone is willing to pay for it at a given point in time. At this point that someone is you!

Why Do I Need to Do My Own Business Valuation?

The business valuation is one of the most important steps in determining whether you buy this business or not. If the Seller’s broker or an outside source has created a valuation report, fine. Get a copy but don’t put a lot of credence in it us it as a guide line. You still need to do your own evaluation.

Remember, the Seller’s accountant has been trying to save the Seller from paying as small an amount of taxes as legally as possible. What shows on the bottom line for tax purposes, in most cases, are not the true earnings of the company. neither does the balance sheet show true market value of the company’s assets because he has been depreciating the business.

Ok, What Do I Need For A Business Valuation?

The following documents are critical for you to do your business valuation.

1. Profit and loss statements for three years, created by an accountant, not created on the seller’s computer.

2. Balance sheets for three years.

3. Federal Tax Returns (IRS) for three years.

4. Interim financials and balance sheets for the most recent reporting period.

5. Complete list of equipment, furniture and fixtures assigned market value.

6. Recent evaluation reports if any.

7. Appraisals on business assets.

8. Marketing and business plans including financial projections.

9. Brochures.

You have gathered all the information you will need to make a buying decision. You are now ready to…

Start Your Business Valuation of The Seller’s Business.

Remember, most businesses are managed in a manner to pay as little income tax as possible to the owner, not to see how much taxes they can pay. That’s why it is important to get a true financial report. You do not have to explain to the Seller why you are reconstructing the financials.

This is a very critical process to decide the worth of the business you are proposing to purchase. If you don’t feel comfortable, get some help.

Some Sellers will have already have done this, that’s okay, but you still want to do your own reconstruction. If the Seller presents you with a business valuation report with the financials reconstructed, watch out for overstated add backs or those items that can’t be verified. You only use numbers that can be verified from the financial information you have gathered yourself.

Things to Watch Out For

Sometimes, in an all cash business, the owner will not report all of his income. I do not listen to Sellers who want to add value to their business from unreported income. I tell them, too bad! The Seller either pays the piper up front or he pays when he sells. I figure if he will lie to Uncle Sam, he’ll lie to me. This should be a red flag.

This profit and loss reconstruction is the major factor in you determining the true worth of the business. You need to discuss each cash flow item with the Seller. You can do this in person or over the telephone. Don’t make a big deal out of this, but do get the information.

If the Seller asks why you need this information, tell him the truth. You are reconstructing his financial statements to show a true market value of his business. Many Sellers are hesitant to discuss some of the perks they have paid themselves. They probably have expensed items that were totally for personal use. These are the items you are trying to locate.

You will use this information only to justify the numbers you find through your reconstruction of the financial statements. You need to make the Seller feel comfortable in discussing these expense items. Assure him this kind of information stays with you and him only.

This process will help you determine the available dollars for you to service the debt, pay yourself or a manager, and give you a reasonable return on investment.

I know what you’re thinking…

This Sounds Complicated And I Need Help!

My book,Who Wants To Be the Boss?, has a whole chapter devoted to business valuation.

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What Makes a Business Worth Investing In?

You have always been interested in investing in a business, however you always hold back because you are scared of making a bad choice and losing your investment. However, there are some ways to evaluate businesses to reduce the risk you are taking when you invest. Of course, risk is never eliminated, but when you properly evaluate what makes a business worth investing in then you will more than likely have your answer whether the company will be a success or failure before you invest your dollars. The following tips will help you make the right investment.

Investment Tip #1 Management

When deciding whether a business is worth investing in or not you need to evaluate the management because a business really is only as successful as its management. Because of this you want to evaluate if the management is knowledgeable, rational, and able to make the right choices to make the company money and prevent it from losing money. Of course, this is an easy question although the answer is a little more difficult.

Investment Tip #2 Business Plan

A business plan that is well laid out and shows positives, negatives, and how the company and management will handle problems within the business is very important. A good business plan shows that management knows where the company is, where it wants to go, and what it needs to do to get there. Be sure you take a look at a company’s business plan before you invest.

Investment Tip #3 Return on Investment

The ROE, or return on investment, is also crucial when you are considering making an investment in a company. Of course, the ratio of equity to debt can be confusing, but if you evaluate the ROE and other economic factors you should be able to tell if the company is bringing money in or losing it.

Investment Tip #4 Room for Growth

Making sure the business has room for growth in its market is also important. A company that has little competition is preferable, but a company with a moderate amount of competition and a plan to be number one is OK as well. Just do your research.

When you are interested in investing in a company you need to take your time and evaluate the company, look over financial statements, talk to management and have all of your questions answered to your satisfaction. After all, it is your money and you aren’t going to give your money to just any company. So, be sure and confident in the company and have that backed up with proof and you will decrease your risk investing in a company.

What is My Business Worth?

Small business owners all over the world usually fail to stop and ask themselves just what their business is worth until they are attempting to sell their business or preparing for retirement. However, gaining early perspective concerning the worth of your business from a third party can greatly benefit the future of your business goals and overall direction. If you are at the point of selling your business or planning for retirement, succession, or divorce, this simple question has no simple answer. Depending on what value is being calculated, a third party could conclude on a much different price when assessing fair market value versus another calculation like most probable selling price.

For the sake of simplification, only the most probable selling price method will be discussed here. Since you are probably hoping to determine the value of your company so you can sell it or pass it on to an heir, this is the method that will be determined. Three approaches can be taken, including market, income and asset approaches. Market approach is when your business is compared to similar businesses that sell the same goods or services and how much they were sold for. This cannot be the only approach however, as comparing businesses in different states that are different sizes from one another can throw off findings.

Income approach calculates how much money your business is generating for you on a yearly basis and determining a reasonable price it could be sold at. Since small businesses are a risk and not guaranteed to generate income, an accommodation must be made for the risk factor. Cash flow is identified through a process known as recasting which involves dissecting tax returns and determining how much money actually benefited the business owner. By following trends of past years, you can calculate estimated future returns the business will make for the new owner.

The final approach is called asset approach. Also known as cost approach, this method deals with physical assets but does not provide much value for goodwill. Many businesses place a good amount of emphasis on goodwill, meaning this would not be the best approach. However, if your business has a number of investments in outside sources, this could be a very beneficial method of determining how much your business is worth. As you prepare to put your business up for sale, understand that negotiations will undoubtedly occur and the market will be the ultimate determining factor of what you can sell your business for.