You might want to own a business at one point or the other for different reasons. It could be that you have always wanted to own a firm for the sake of it. Many people found companies simply because it is their dream to found one. Others do it for financial independence. No matter the reason for starting a business, the most common way to come into the ownership of an enterprise is to start one yourself, in which case you are responsible for the business from scratch.
However, when you are looking to buy a company from another party, one of the considerations you have to make is the worth of that business. How much should you spend on buying a company? If you are not sure, read these four ways you can use to value a small business for purchase.
How to value a business
Using Discounted Cash Flow
The amount of money available to a business owner for operational expenses at any given time indicates the financial health of a company. Under this method, you assume the cash flow is consistent and use it to make projections of the future earnings of the business. By plugging in various cash flow variations, you can get a rough estimate of what the firm will be worth in a few years, and consequently its current market value.
More often than not, a quick look at the balance sheet will give you insight into the financial status and value of a company. A company that is rich in assets including but not limited to buildings, equipment and inventory is more likely to command a higher price than one that is asset poor. However, this method is imperfect because it does not take into account the fact that having relatively valuable total assets does not necessarily mean that a company generates significant revenue.
When you are buying a car and look up a vehicle in multiple dealerships, you expect the prices to be relatively similar because you are essentially shopping for the same car. The same goes for businesses. If you want to value a small business for purchase, you can do so by looking at the selling price for similar businesses recently bought in the area. The range between your offering price and that of selling prices for similar businesses should be minimal should you use this method.
Many industries have fixed sales revenue or cash flow multipliers you can use to appraise a small business. For instance, in an industry with a revenue multiplier of .6, you can make an offer of $60,000 for a business whose gross revenue lies at $100,000. Income multipliers are convenient to use when you want a fast estimate. However, this method may be inaccurate because higher revenue does not always indicate higher profits.
It is best to consult an independent business valuation company before you decide which appraisal method to use to value a small business for purchase. Each method has its benefits and drawbacks and is therefore suited to individual case valuations.
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