The value of a business ultimately depends on the buyer’s price. There is no right way to objectively determine the value. However, as Steven Robins states in his question and answer column (Entrepreneur, January 11, 2004), “you could probably come up with several wrong ones.”
The idea of business valuation is to predict how likely you are to win or lose in this business situation.
• Start by looking at the value of the business assets. What does the business own, equipment, inventory, i.e., replacement costs.
• The business’ books. A company’s financial documents (i.e. balance sheets, income statements, etc.) may give a good idea of the value of assets and the level of profit.
• You can look at the business as a money stream. A company’s revenue may be able to give you an estimate of value. Utilizing business valuation databases, business valuation consultants may be able to determine an estimate of value based on a multiple of its revenue. Looking at purchase prices for similar businesses you can sometimes work out what that multiplier is.
• Perhaps profit is the fundamental measure of business value. Estimation of the profit over several years can give you a sense of how much the business is actually worth to you, as a practical matter.
• You need a goodly sample of profit numbers to take a reliable measure of value, since profits fluctuate with the activities of competitors and market conditions.
• Many estimators use the technique of factoring interest rates into their calculations, as if you were going to invest the business profits every year, to determine value. This will give you a measure of how much in treasury bills you would have to buy to equal the business’ profit.
Sometimes non-financial and, perhaps, less quantifiable things can enter into business value estimates. As an example, location can play a role. A business may be more valuable if its located conveniently to the owner. If the business meets some ideal or some long-held dream it could be worth more. However, someone estimating the value of a business should be careful not to let the heart too thoroughly rule the head.