How to Value a Small Business

If you are considering buying a small business you will need to do a business valuation first. It isn't always easy to figure out how much the business is worth. There are different methods of valuation that you can use, and a lot of the decision as to which one you will use will depend on the kind of business you are purchasing. For example, you might use different methods of valuation for an IT consulting company, internet marketing company, a computer repair business, a restaurant, or a manufacturing company. This article will discuss a few different methods to value a small business.

Difficulty: Moderately Easy

Instructions

Things You'll Need:

• Historical information about the small business you are interested in buying.
• Access to a computer

1. 
    

   GATHER AS MANY YEARS OF FINANCIAL INFORMATION AS YOU CAN ABOUT THE SMALL BUSINESS, RESEARCH THE INDUSTRY, THE LOCATION, THE COMPETITION, AND CONSIDER THE ECONOMY. Without sufficient information about past performance of the business, it is difficult to predict the future. You do not buy a business in a vacuum, so it is equally as important for you to do your homework on all the other factors that can make or break a business.

2. DON'T PAY MORE THAN FAIR MARKET VALUE FOR THE SMALL BUSINESS YOU ARE INTERESTED IN BUYING. It goes without saying that you don't want to pay more than business is worth. You can use one of the methods discussed in the next few steps, or have a business appraisal done by a business valuation consulting firm.

3. 
    

   FOR SERVICE COMPANIES MANY APPRAISERS USE ADJUSTED NET CASH FLOW WITH A MULTIPLE. When you are purchasing a service company like a consulting firm or a computer services company, the main assets are the employees, its customer relationship management, marketing plan, management plan, and goodwill. The multiple often used for in the services industry is 2 to 2 1/2. Each industry has their own rule of thumb for multiples.

4. FOR A SMALL BUSINESS THAT PRODUCES MANUFACTURED GOODS, USE A MULTIPLE OF EARNINGS BEFORE INTEREST AND TAXES (EBIT). Since there is a greater need and use for capital expenses and you produce a product that you will have to carry on inventory, this is the method used most often by business valuation appraisers.

5. 
    

   FOR SMALL BUSINESS'S THAT ARE IN DISTRESS AND LOSING MONEY, YOU CAN USE BOOK VALUE OR LIQUIDATED VALUE. This is total assets minus total liability. In this situation, you are not calculating earnings or goodwill. You will still use a industry rule of thumb for a multiple in this case.

Tips & Warnings

• If you live in a large enough city, you may also have market comparables available to you. Since each business is unique though, this not be the final work but just provide one more piece of information on which to base your offer.
• Do your own independent research and don't depend on the realtors to give you an objective appraisal. Go to the SBA website for more information. I have provided a link to it in the "resources" section below.

Resources

• Small Business Administration - Small Business Planner

[ghostwoman]

on 9/12/2009 Excellent article on how to value a small business.

Recommended and 5*s. I enjoyed reading your work!

[femwriter]

on 8/30/2009 This is a very informative and timely article. Thanks for writing this one! 5*

[kp3028]

on 8/22/2009 The biggest asset a company has at the time of sale, is it s'customer base'; a new business owner thinks that the customers will remain after ownership changes, yet often, very often, customers leave regardless of how much the company remains the same to them.

[1960texan]

on 8/22/2009 Great tips, and I know from personal experience that the numbers you show for service businesses are right on the money.

[langleycornwell]

on 8/14/2009 Very good and informative article on valuing a small business.