Are you wondering, “how much is my business worth?”.
When looking to sell your business, there are many methods you can use to calculate the worth of your business. However, the suitability of a given method depends on the size of your business, and the industry in which it operates.
Here are three popular models used to estimate how much a business is worth.
Net Profit Method
The net profit method is based on the net profit earned by the business. It takes the annual net profit (either as an average of the last several years, or of the most recent year) and multiplies it by a rate – often from a rate of 1.4.
Net profit x rate = value according to net profit method
The benefit of this method is that it is suitable for establishing a price that buyers in the market are willing to pay. This is because the rate represents the amount of time it would take to regather the investment of buying the business.
For example, if your business over the last three years had an average net profit of $250,000, and this is multiplied by a rate of 1.5, it would price your business at $375,000. This means that, all else being equal, it would take 1.5 years to earn back what it cost to acquire the business.
The downfall of this method is that it might be somewhat less concrete than other methods. The rate used in the calculation is typically set in line with regular practice, or according to what seems a fair amount of time to recoup the investment of acquiring the business.
While this may be “fair value”, it is not necessarily the “real value”.
Net Worth Method
This method takes into consideration the total assets and liabilities of the business. It is calculated as follows:
Total assets – Total liabilities = net worth
For example, if your business has total assets worth $200,000, and total liabilities of $50,000, then according to this method, your business’s worth would be $150,000.
One clear benefit to this method is that it is based on the real book worth of the business. There is no second guessing the final figure.
However, this method is not always suitable. Some businesses – particularly service based-businesses – don’t always have a significant amount of assets or liabilities. If a business with low amounts of assets and liabilities was to be valued in this method, the result could be very small.
Comparative Method
The comparative method simply takes the average sale price of like-businesses (i.e. similar businesses to yours) in order to come to a final value or worth.
For example, if the average of sale price of 5 similar businesses was $550,000, then on that basis, you would price your business at a similar price.
The reasoning behind this method is that it simply represents the market’s willingness to pay for such a business.
Conclusion
Our business brokers typically employ the net profit method to arrive at a reasonable estimated sale price. This is because it best reflects the price buyers are willing to pay. Other methods, such as the net worth method, are more relevant for larger sized businesses. But again, it may not always reflect the price that buyers are willing to pay.
Considering each method and the result each method brings is recommended for larger sized businesses, in conjunction with reviewing sale prices of recently sold businesses of a similar kind.
