How to Compute a Business Value Using Rule of Thumb

Business calculations.

One of the trickiest components of selling or financing a business is determining its value. Because each business is unique and is a more abstract entity than a house or a car, for example, there is a wide margin for error in computing its value. Some of the formulas for creating a valuation are complex and require expert skills. But to formulate a rough, educated guess, you can use a rule of thumb.

Instructions

1. Define which industry the business is in. Some businesses will be fairly obvious; for instance, a grocery store is in the grocery industry. Others are more nebulous: is Salesforce.com a software development company, a business services company, a sales company or a software retailer? When in doubt, select the industry about which you have the most information.

2. Calculate the business' earnings before interest and taxes (EBIT.) If the company is not yet profitable or is in a period of high growth, you may estimate next year's earnings rather than the using the previous year's figure. At a company with a volatile earnings pattern, take an average of the previous three to five years. Alternatively, you can use sales rather than earnings.

3. Research the average sale price of companies of similar earnings in that industry. Use historical figures for the past three to 10 years, choosing longer time frames for industries with lower turnover. Some companies might have been sold at a discount during a period of distress, and others might have lucked out at the height of a speculation bubble, so eliminate those companies from the average whenever possible.

4. Divide the average sale price by the average EBIT, or sales volume, of those companies. This will give you the typical "multiple" for your industry. A typical multiple is usually between less than one and up to three times sales, or in early stage companies and good economic times the multiple can be up to 20 or even 80 times earnings.

5. Multiply the typical industry multiple by your company's EBIT or sales. For instance, if you're a mid-stage software services company, you might discover that the multiple is 1.5 times sales. If your business did $1 million in sales last year, the rule of thumb states that your business is worth $1.5 million.

References

• Service Corps of Retired Executives (SCORE): How to Value Your Business
• Business Brokers: Value Methods
• Merfeld & Schine: Business Valuation

Resources

• BizBuySell: Valuation Rules of Thumb