Adapted from content excerpted from the American Express ® OPEN Small Business Network

There are many occasions when you must assess the value of a company. Buying and selling a business are probably the most common reasons. Other reasons include: estate planning, reorganization, or verification of your worth for lenders or investors.

Valuing a company is far from an exact science and can depend on the type of company and purpose of the evaluation. There are a wide range of factors that go into the process: the book value to a multitude of tangible and intangible. In general, the enterprise value based on an analysis of its cash flow. In other words, its ability to generate consistent profits will determine its value in the market ultimately.

The evaluation of a company should be considered a starting point for buyers and sellers. It is rare that buyers and sellers achieve the same amount, even if only because the seller is looking for a higher price. Your goal should be to establish an approximate price at which the buyer and seller can negotiate a price with which they will both be comfortable. Look carefully at the numbers, but keep in mind this caution from Bryan Goetz, president of Capital Advisors, Inc.., A business appraiser: “Businesses are as unique and complex that people who lead and do can be evaluated with a simple rule of thumb. ”
Some common methods used to reach a value:

* Asset valuation
* Evaluation of the income capitalization
* Evaluation of owner benefit
* Multiplier or valuation of the market

Valuation of assets

The asset valuation is used when a company has significant assets. The retailers and manufacturers fall into this category. This process takes into account the following amounts whose sum is the value:

* Fair market value of property and equipment (FMV / FA) – This is the price you would pay on the open market to purchase the assets or equipment.
* Leasehold improvements (AL) – These are the improvements to the physical property that would be considered part of the property in case of sale or non-renewal of the lease.
* Profits from the owner (CP) – It is the seller’s discretionary cash for the year. You can get adjusted income statement.
* Inventory (I) – Wholesale value of inventory, including raw materials, work in process and finished goods or products.

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Evaluation of the income capitalization

This method does not give value to assets such as equipment and takes into account a greater number of intangibles. It is preferable to use the valuation method for companies without assets such as service companies.

In his book “The Complete Guide to Buying a Business” (Amacom, 1994), Richard Snowden cites a dozen factors that should be taken into account when using the evaluation of the income capitalization. It recommends giving a score from 0 to 5, with 5 being the highest rating. The average of these factors will be the “capitalization rate” which is multiplied by the money available to the buyer to determine the market value of the company. The factors are:

* Reason for sale owner
* Length of time the company has been in business
* Length of time current owner has owned the company
* Risk level
* Profitability
* Location
* History of Growth
* Competition
* Barriers to market access
* Potential future industry
* Customer
* Technology

Again, add the total scores and divide by 12 to obtain an average value to use as the capitalization rate. Then you must reach an amount of money available to the buyer which is 75% of owner benefit (seller’s discretionary cash for one year as reported in the income statement). You multiply the two numbers to get the value.

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Rating Owner benefit

This formula focuses on the cash seller and is most often used for valuing businesses whose value derives from their ability to generate cash and profits. The formula is relatively simple: we multiply the owner benefit times 2.2727 to get the value. The multiplier takes into account standard figures such as 10% return on investment, a basic minimum of 30% of owner benefit and 25% of expenses for reimbursement. (I do not think whether “debt service” here – to check.

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Multiplier or valuation of the market

This approach finds the value of a company using an “industry average” as a multiplier. The value of the industry average based on recent selling prices of comparable businesses. It follows the development of a formula specific to the industry, usually a multiple of revenues. It is here that some people have problems with these formulas, because often they do not reflect the net profits or cash And they do not take into account differences that may exist between two companies in the same industry .

Here are some examples of multipliers by industry as mentioned in “The Complete Guide to Buying a Business” by Richard Snowden (Amacom, 1994):

* Travel agencies – from 0.05 to 0.1 X annual turnover gross
* Advertising Agencies – 0.75 X annual turnover gross
* Retail – 0.75 to 1.5 X annual net profit + inventory + equipment

To find the right multiplier for your industry, you can try contacting your trade association. Another solution is to use the services of a broker or appraiser who specializes in your type of business.

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