What’s It Worth? 9 Key Factors for Business Valuations

Do You Need a Business Valuation?

Whether you’re buying or selling a business, a business valuation is a necessary step in the process. You might be more familiar with the term “business appraisal.” These two interchangeable terms describe a complicated process used to determine what a business is worth.

There is no “cookie cutter” way to do this. There are different types of business valuations for different circumstances. There are some circumstances where a formal valuation is needed. In other instances, a less formal approach can be taken. We will help you navigate the various types of business valuations and determine which type of appraisal you need for your specific circumstances.

What Is My Small Business Worth?

Every business owner (and potential business owner!) wants a simple clean answer. Unfortunately, too many business brokers, CPAs, and fishing buddies are more than happy to give them a simple yet incorrect one.  The process of pricing a small business is like preparing a complex meal. You put in a lot of key ingredients to get to the end result.

9 Key Ingredients for Pricing a Small Business Correctly

  • Sales revenue – Is the business growing? Shrinking? Is it volatile year-to-year?
  • Profits – After adjusting for the owner’s earnings, what profit is the business actually making?
  • Customer Concentration – Is the largest customer a large part of the total business sales? Is it the same large customer every year? What is the risk of losing that customer?
  • Vendor concentration – Is the business dependent on a critical supplier? Is there a replacement supplier if something goes wrong?
  • Family members – Who is involved in the business?
  • Big industry or regulatory changes – What shifts are in the works?  Good or bad?
  • Financial records – Does the profit and loss statement accurately reflect the financial performance of the business? Can the tax returns and P&L be reconciled easily?
  • Accounting – Is the accounting done on a cash basis? Accrual? Are tax returns and financial statements prepared with consistent accounting principles?
  • Current interest rate – What is the present interest environment? Generally speaking, the higher the interest rates the lower the business value to a buyer due to the higher cost of borrowing to pay for the business.

And the list of issues goes on! The best advice: ignore any “Rule of Thumb” advice.  Contact us to set up a frank, confidential discussion. We can guide you through the process of determining a price for your business in today’s market that will help you meet your goals.

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Business Valuation: Do the Financials Tell the Whole Story?

Many experts say no! These experts believe that only half of the business valuation should be based on the financials (the number-crunching), with the other half of the business valuation based on non-financial information (the subjective factors).

What subjective factors are they referring to?  SWOT is an acronym for Strengths, Weaknesses, Opportunities and Threats – the primary factors that make up the subjective, or non-financial, analysis. Below you will find a more detailed look at the areas that help us evaluate a company’s SWOT.

Industry Status – A company’s value increases when its associated industry is expanding, and its value decreases in any of the following situations:  its industry is constantly fighting technical obsolescence; its industry involves a commodity subject to ongoing price wars; its industry is severely impacted by foreign competition; or its industry is negatively impacted by governmental policies, controls, or pricing.

Geographic Location – A company is worth more if it is located in states or countries that have a favorable infrastructure, advantageous tax rates, or higher reimbursement rates.  A company with access to an ample educated and competitive work force will also enjoy increased value.

Management – A company with low turnover in management and a solid second-tier management team comprised of different age levels is also worth more.

Facilities – A company operating profitably at 70 percent capacity is worth more than a company currently near capacity. Equipment should be up to date and any leases – either equipment or real estate – renewable at reasonable rates.

Products or Services – A company is worth more if its products or services are proprietary, are diversified with some pricing power, and have, preferably, a recognizable brand name. In addition, new products or services should be introduced on a regular basis.

Customers – A company is worth more if there is not heavy customer concentration, but rather recurring revenue from long-time, loyal customers, as well as from new customers created through a regular and systematic sales process.

Competition – A company not contending head to head with powerful competitors such as Microsoft or Wal-Mart will rate a higher value.

Suppliers – Finally, a company is worth more if it is not dependent on single sourced key items or items available from only a limited number of suppliers.

 

Copyright 2012 Business Brokerage Press, Inc.