Determining How Much Your Business Is Worth

As an entrepreneur, you put your heart and soul into your company, but if you're interested in determining how much your business is worth, you’ll need to take an objective approach to evaluate your company’s prospects.

There are multiple ways to determine the value of a business, which is why you will often see conflicting numbers when a company is being sold. The best measurement may be to take an average of several different such calculations.

Assets

Assets include the building in which the business is housed, any specialized equipment that might be used to produce its goods or services, and any inventory the business has. This is often considered a good starting point for assessing business value simply because you would need to buy all of these things if you were to build a similar company from scratch.

Leases, permits, trademarks, and customer lists are also considered assets, although these items don’t have an easily determinable cash value. If you’re selling your business and can provide these items, however, you should consider trying to negotiate for a slightly higher price.

Revenue

Revenue is the amount of money the business takes in each year. For example, a shop may have $100,000 per year in sales. When this is used as a calculation for determining business worth, it’s often as a “two times sale” – two times the current yearly revenue generation.

However, higher or lower numbers may be used if there is evidence to indicate the revenue generation potential isn’t stable on a long-term basis.

Consulting firms, advertising agencies, insurance brokers, and professional practices are all examples of businesses where worth is calculated based on annual sales.

Earnings

Earnings refer to the amount of money your business makes after expenses are subtracted from revenue. A business can have a large amount of revenue, but low earnings if it requires substantial overhead costs. Earnings can also vary according to factors such as competition and price changes in essential materials.

Warren Buffett’s method of calculating how much a business is worth is known as a discounted cash-flow analysis. This looks at how much cash a business generates each year, makes a future cash projection, and then figures the worth of that stream "discounted" using the long-term Treasury bill interest rate.

Recasting Financials

If you’re planning to sell your business, keep in mind that the buyer will ask to see documentation of any claims that you are making as to your company’s worth. For this reason, it would be a good idea to have an accountant go over your books to verify that your financials are in order. An accountant can also assist with recasting financials to better reflect cash flow.

This process is very detailed and involves steps such as deducting surplus staff that could be eliminated by the new owner or removing fees for one-time expenses the new owner would not incur. Recasting is not the same as “cooking the books” because there must be legitimate reasons for all changes and the prospective buyer must receive both sets of documents for comparison purposes.

However, the benefit of recasting is that it can be used to justify a higher asking price for your company.