Understanding Business Valuations

When you are considering purchasing a business, it is helpful to examine the situation from the perspective of the seller. When you look at prices that are attached to prospective companies that you are interested in purchasing, it is easy to think that the number got pulled out of thin air. However, there are a series of valuation techniques that an appraiser uses to arrive at, what they believe to be, a fair price. As the buyer, it is helpful to know these techniques so that you can determine whether or not the deal is one that will benefit both parties. The following are the techniques that are most commonly used to value a company.
Value Based on Cash Flow and Profits
One of the most used ways to generate a sale price for a company is by considering its ability to generate sales and bring in money. The major figure that is looked at first is the value of annual sales. This figure can then be affected by what are referred to as industry multipliers. This number allows the original figure to be adjusted based on certain characteristics of the company that are believed to increase its value. This multiplier typically increases the value of the company by 2 to 3 times. Many different factors can affect the multiplier, such as economic issues, the size of the business, how long the business has been around, and certain risks that the new business owner may face. Examples of factors that positively affect the multiplier are weak competition, diversified products and proprietary products. Examples of factors that will have a negative impact on the multiplier amount are too many competitors and a declining market.
Value Based on Assets
Value based on assets takes a look at both the tangible and intangible components that make up the company. Companies may choose to use this method if their selling their company when it is not in its most successful condition. Choosing to focus on assets rather than cash flow is a more successful method for the seller and will more appropriately value their business. This method is used to determine the tangible assets, first. This includes things like the facility and the product owned by the company. This value comprises the rock bottom value and acts as the starting point. After this has been determined, the intangible assets are considered and added to the figure. Intangible assets include things like customers, brand name, and trademarks. Using this method usually requires a business owner to hire an appraiser. When purchasing a company, make sure to ask for an overview of the assets that they included in the price and the value of each.
When listing a company, a seller will often use both of these valuation methods and choose the one with the outcome that benefits them the most. Having an understanding of each process will help you to determine the fairness of the asking price. Having this knowledge will also give you some leveraging power to negotiate. Empower yourself by learning the appraising and valuing process and set yourself up to make a wise and profitable business purchase.