Let’s say that you learn a local business owner is ready to retire. The prospect of acquiring his or her company seems intriguing and feasible. But is it a good investment? And how much should you offer? Here are three steps that will help you determine a company’s value:
- Don’t only rely on a third-party valuation. Associations and trade groups in the industry may provide guidelines, often expressed as a percentage of sales or asset values. Valuations based on these estimates are free and, as the saying goes, “you get what you pay for.” A general guideline may work as a starting point, but the one-size-fits-all approach is rarely sufficient to provide an accurate picture of a company’s worth.
- Consider using business valuation software. This approach may provide a better estimate because it’s based on more factors. You input asset and income information from the company’s financial statements and/or tax returns into the application, and the software cranks out a fair market value or, more likely, a range of values.
- Perform a financial statement analysis. You calculate the company’s book value, the difference between its assets and its liabilities as presented on the balance sheet. Unfortunately, this approach can be misleading, especially if the assets are presented at historical cost. Some assets may have declined in value. For example, inventory may be obsolete or accounts may be uncollectible.On the other hand, the business may own real estate that’s appreciated since being purchased. You may also want to project future cash flows and discount them to the present using an assumed rate of return.
Historical profits, industry trends, competitors, intangibles, customer demand – these factors and many others impact a company’s value. As a result, depending on your resources and interest, you may want to consider hiring a professional business valuator.
Be aware, however, that the final selling price will likely differ from any theoretically-derived value.