How to Measure the Financial Value of a Consulting Firm

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There are two primary methods of valuing a business. One method is based on the asset value, while the other is based on past earnings. Both methods have benefits and drawbacks. There is no one "right" method.

Valuing a consulting business is similar to valuing any other business, with the exception that much of the value of the consulting business is based on the consultants themselves. The two keys to successful consulting are relationships held by the consultants and the industry-specific knowledge held by the consultants. This is called "goodwill" and must be accounted for.

The Asset Valuation Method

Look at the profit and loss statements, the balance sheets and the tax returns for the past five years. Pay attention to the purchase price of the equipment and hard assets owned by the business. Add these purchase prices together.

Look at the depreciation schedule on the tax returns. See how much the assets have depreciated. Note whether or not the business took "accelerated depreciation" -- a legal accounting trick to make the assets seem like they're worth less than they really are for tax purposes. If the business did take accelerated depreciation, hire an appraisal company to assess the true value of the assets.

Calculate a "fair return" on the assets -- for example, you may calculate a 10 percent return on assets every year, which means that for every \$100 in assets the company owns, you expect to earn \$10 per year. You may base this fair return on comparable companies, industry growth or risk level.

Calculate "goodwill." This is a measure of the intangibles, like the knowledge, relationships and reputation of the consultants or of the business as a whole. You can calculate this by coming up with a variable that represents the excess earnings over what a fair return would be.

Calculate the tax consequences of buying the business, and factor this into your expenses. Consult a tax specialist to help you do this, as the tax code changes every year.

The Past Earnings Method

Look at the profit and loss statements and balance sheets for the past five years. See how much the company has earned, both in gross revenue (total sales) and net revenue (money left over after all the bills are paid).

Bear in mind that many companies purposely -- and legally -- make their net revenue look artificially small in order to minimize taxes. Common ways of doing this are by paying out bonuses, giving expense accounts, or accelerating depreciation.

Take the average earnings of the past five years, and multiply that amount by a number that represents the estimated value of the company. This multiplier will represent how much you believe the company is worth based on its asset-to-debt ratio, the goodwill of the employees and the goodwill of the company reputation, and other intangibles. There is no formula for coming up with this multiplier. It should reflect how much money you believe the company can earn in the future.

Couple this method with the asset valuation method for a better picture of the company value. Since so many intangibles go into both methods, performing both valuations will help you get a clearer picture.

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