{"id":338,"date":"2019-07-24T11:50:58","date_gmt":"2019-07-24T11:50:58","guid":{"rendered":"https:\/\/www.sivioinstitute.org\/labs\/sec\/?page_id=338"},"modified":"2019-08-27T12:16:51","modified_gmt":"2019-08-27T12:16:51","slug":"business-valuation-methods","status":"publish","type":"page","link":"https:\/\/www.sivioinstitute.org\/labs\/sec\/dynamics-of-growth\/business-valuation-methods\/","title":{"rendered":"Business Valuation Methods"},"content":{"rendered":"\n\tYou are here:\n<span><span><a href=\"https:\/\/www.sivioinstitute.org\/labs\/sec\/\">Home<\/a><\/span><\/span>\n\n\t<h1>Business Valuation Methods<\/h1>\n<p>You may be thinking of re-investing profits from your company. Many times people invest in entities before carrying out adequate analysis. In this presentation we present a step by step approach to identifying investment opportunities.<\/p>\n<p>Valuing a company is hardly a precise science and can vary depending on the type of business and the reason for coming up with a valuation. There are a wide range of factors that go into the process &#8212; from the book value to a host of tangible and intangible elements. In general, the value of the business will rely on an analysis of the company&#8217;s cash flow. In other words, its ability to generate consistent profits will ultimately determine its worth in the marketplace.<\/p>\n<p>Business valuation should be considered a starting point for buyers and sellers. It&#8217;s rare that buyers and sellers come up with a similar figure, if, for no other reason, than the seller is looking for a higher price. Your goal should be to determine a ballpark figure from which the buyer and the seller can negotiate a price that they can both live with. Look carefully at the numbers, but keep in mind this caution from Bryan Goetz, president of Capital Advisors, Inc., a business appraiser: <strong><em>&#8220;Businesses are as unique and complex as the people who run them and are not capable of being valued by a simplistic rule of thumb.&#8221;<\/em><\/strong><\/p>\n<p>Here are some of the common methods used to come up with a value.<\/p>\n\t<h2>Asset Valuation<\/h2>\n<p>Asset valuation is used when a company is asset-intensive. Retail businesses and manufacturing companies fall into this category. This process takes into account the following figures, the sum of which determines the market value:<\/p>\n<ul>\n<li>Fair market value of fixed assets and equipment (FMV\/FA) &#8211; This is the price you would pay on the open market to purchase the assets or equipment.<\/li>\n<li>Leasehold improvements (LI) &#8211; These are the changes to the physical property that would be considered part of the property if you were to sell it or not renew a lease.<\/li>\n<li>Owner benefit (OB) &#8211; This is the seller&#8217;s discretionary cash for one year; you can get this from the adjusted income statement.<\/li>\n<li>Inventory (I) &#8211; Wholesale value of inventory, including raw materials, work-in-progress, and finished goods or products.<\/li>\n<\/ul>\n<h2>Capitalization of income valuation<\/h2>\n<p>This method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses like service companies.<\/p>\n<p>In his book &#8220;The Complete Guide to Buying a Business&#8221; (Amacom, 1994), Richard Snowden cites a dozen areas that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the &#8220;capitalization rate&#8221; which is multiplied by the buyer&#8217;s discretionary cash to determine the market value of the business. The factors are:<\/p>\n<ul>\n<li>Owner&#8217;s reason for selling<\/li>\n<li>Length of time the company has been in business<\/li>\n<li>Length of time current owner has owned the business<\/li>\n<li>Degree of risk<\/li>\n<li>Profitability<\/li>\n<li>Location<\/li>\n<li>Growth history<\/li>\n<li>Competition<\/li>\n<li>Entry barriers<\/li>\n<li>Future potential for the industry<\/li>\n<li>Customer base<\/li>\n<li>Technology<\/li>\n<\/ul>\n<p>Again, add up the total ratings, and divide by 12 to come up with an average value to use as the capitalization rate. You next have to come up with a figure for &#8220;buyer&#8217;s discretionary cash&#8221; which is 75% of owner benefit (seller&#8217;s discretionary cash for one year as stated on the income statement). You multiply the two figures to determine the market value.<\/p>\n<h2>Owner benefit valuation<\/h2>\n<p>This formula focuses on the seller&#8217;s discretionary cash flow and is used most often for valuing businesses whose value comes from their ability to generate cash flow and profit. It uses a fairly simple formula &#8211; you multiply the owner benefit times 2.2727 to get the market value. The multiplier takes into account standard figures such as a 10% return on investment, a living wage equal to 30% of owner benefit, and debt service of 25%.<\/p>\n<h2>Multiplier or market valuation<\/h2>\n<p>This approach finds the value of a business by using an &#8220;industry average&#8221; sales figure as a multiplier. This industry average number is based on what comparable businesses have sold for recently. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. This is where some people have trouble with these formulas, because they often don&#8217;t focus on bottom line profits or cash flow. Plus, they don&#8217;t take into account how different two businesses in the same industry can be.<\/p>\n<p>Here are a few industry multiplier examples, as mentioned in &#8220;The Complete Guide to Buying a Business&#8221; by Richard Snowden (Amacom, 1994):<\/p>\n<ul>\n<li>Travel agencies &#8211; .05 to .1 X annual gross sales<\/li>\n<li>Ad agencies &#8211; .75 X annual gross sales<\/li>\n<li>Retail businesses &#8211; .75 to 1.5 X annual net profit + inventory + equipment<\/li>\n<\/ul>\n<p>To find the right multiplier for your industry, you can try contacting your trade association. Another option is to utilize the services of a broker or appraiser who specializes in businesses such as yours.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Business Valuation Methods You may be thinking of re-investing profits from your company. Many times people invest in entities before carrying out adequate analysis. In this presentation we present a step by step approach to identifying investment opportunities. Valuing a company is hardly a precise science and can vary depending on the type of business &#8230; <a title=\"Business Valuation Methods\" class=\"read-more\" href=\"https:\/\/www.sivioinstitute.org\/labs\/sec\/dynamics-of-growth\/business-valuation-methods\/\">Read more<\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"parent":326,"menu_order":0,"comment_status":"closed","ping_status":"closed","template":"","meta":{"footnotes":""},"class_list":["post-338","page","type-page","status-publish"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v25.6 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Business Valuation Methods - SIVIO Entrepreneurship Lab<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.sivioinstitute.org\/labs\/sec\/dynamics-of-growth\/business-valuation-methods\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Business Valuation Methods - SIVIO Entrepreneurship Lab\" \/>\n<meta property=\"og:description\" content=\"Business Valuation Methods You may be thinking of re-investing profits from your company. 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