As we’ve said before, buyers’ and sellers’ perspectives of the value of a business differ greatly. Both seek a good deal, the buyer wanting to pay as little as possible and the seller wanting maximum profit for the business he built with sweat and tears. Both perspectives have validity and are understandable. Therefore, using a sound method for determining actual value makes good sense.

Creating Value

The following factors create value in a business:

• A good recent profit history
• Good condition of company facilities, accuracy of books, employee morale, goodwill in the community.
• Demand for a specific type of business
• Current economy – the more investment capital available, the better the demand for purchasing good businesses
• Transferability of company assets. If intangible assets make up the bulk of the business’ assets, buyers question the viability since the asset may not transfer well to new owners
• Future profit potential – where is this business in the marketing cycle? Is the market pretty well saturated? Will the products become obsolete? Or is the business relatively young?
• Special circumstances of buyer or seller. If either the buyer or seller needs the sale, the resulting price changes based on the need. If the seller needs to sell, the price decreases. If the buyer needs a business investment, the price probably increases.
• Special terms available. Buyers may pay more for a business with special financing terms such as: less cash down, seller financing, lower payments at the start of the loan, etc.
• Tax consequences. Sellers experiencing a huge tax debt based on a sale stick harder to their asking price.

Valuation Methods to Avoid

While a “rule of thumb” might give you the ballpark price of a certain type of business, avoid using it to actually determine price. There is no such thing as a “one size fits all” in business. Location, inventory, the current state of the economy and many other factors toss “rule of thumb” rules right out the window

Comparable Sales once again provides a bench mark for the value of a business, but by no means provides a good sales price. No business is like another even if they sell the same product. The condition of the business, both physical and internal structure, changes from business to business

Reliable Valuation Methods

The adjusted book value balance sheet method of valuation provides a good look at value. (Note: Three balance sheet methods exist in accounting, book value, adjusted book value and liquidation value. Book value varies depending on accounting methods used, liquidation value really looks at the value at disillusion of a business.) Adjusted book value takes into account possible allowable but deceptive accounting methods. It looks at valuating the business assets in their current condition less current liabilities. Adjustments might also be made for obsolete inventory or inventory in poor condition, old accounts receivable, current market value of real estate, age and condition of furniture and fixtures.

The income statement method of valuation provides the most meaningful approach of valuation to the buyer. The buyer wants not only value, but cash flow, in order to remain a viable business. The discounted cash flow method looks first as historical cash flows and then projects future cash flows. Future cash flows are discounted to current value with a calculation for the residual value of the business at the end of the future cash flow projection. However, even the balance sheet and income statement methods of valuation are not without error. Looking at both methods of valuation along with viewing comparables and “rule of thumb” figures may give the buyer the most accurate point in which to start negotiations.