How To Determine the Value of a Business - By: Richard K Parker

If you're looking to buy a business, it's important to know its value so you can determine a fair purchase price. Keep in mind that the buy business asking price set by the seller is probably far from what the business is actually worth. That's why it's necessary for you to conduct a business valuation to determine its true value.

A business valuation is a common component of any buy business transaction. Keep in mind that buyers value a business differently than sellers. Sellers place a high price on their business because of the history they have with it, their emotional attachment to it and the hard work they've put in over the years. But when you value a business, those factors should not be calculated in the purchase price.

To value a business, there are five ways to determine its worth. They are liquidation value, asset valuation, income multiple, income capitalization and rules of thumb. Before you purchase a business, you should decide which strategy will give you the most ideal business valuation.

1. Liquidation Value. This is based on the value of the company's assets if they were forced to sell in under 12 months.

2. Asset Valuation. This method factors in all assets of a business and calculates price appropriately. It is probably the least favored business valuation method for those considering buying a small business. That's because even though a business may have excellent assets, it still may not take in enough profit.

3. Income Multiple. The net income and other factors determine the selling price. This is the preferred method to use to value a business.

4. Income Capitalization. Historical data and various hypotheses are used to calculate future income of the business. This buy business method is typically used for large business purchases.

5. Rules of Thumb. The selling price of similar businesses is factored in to cash flow or a percentage of revenue equation. Since this calculation is too general, it's not the best way to value a business.

Of all these business valuation methods, the Income Multiple calculation is the most beneficial to buyers because it provides an accurate amount of how much profit they can expect from the business. In buy business terms, this is known as the Owner Benefit, also referred to as Seller's Discretionary Earnings or Adjusted Earnings.

The Owner Benefit is based on past financials. It is the amount the buyer can expect to meet salary, pay any debt and market the business. But for a true calculated amount, it's important to ask the seller what formula was used to arrive at the Owner Benefit figure.

The optimal formula to use is: the pre-tax profit + owner's salary + additional owner's benefits or other perks + interest + depreciation less an allocation for future capital expenditures where appropriate. History has shown that this formula is more conducive in terms of value of business accuracy.

When you buy a business based on the Owner Benefit figure, you can expect to pay anywhere from one to three times of the business valuation amount. Typically, the one-time multiple figure is used when buying a consulting business or professional service run by the seller. The three times the Owner Benefit figure is usually what businesses should get if they've been in business for longer than three years, have a significantly sized customer base, some proprietary items, a competitive edge, and better then average expantion potential.

The Owner Benefit is just part of the equation when you buy a business. When you value a business, actual multiples have to be taken into consideration. These include basic buy business fundamentals, such as how long it has been in business, lease terms if the location is key to the business, its competition, the employees, systems, deal terms, the extent of its customer base, loyalty of customers, past stability of the company, and most importantly, how well the business will transition to new ownership.

The multiple aspect covers all tangibles that go to the core of a business. When you buy a business, it is essential to know and evaluate what the business valuation means to you. There are resources that can assist you with these buy business methods. But if you're planning to purchase a business, it's crucial that you find out how to read and analyze financial documents.

Once you value a business, it will help with your decision on whether to buy it and at what price. When you implement buy business strategies, you will be more confident in negotiating a deal with terms of value that meet your needs. Understanding business valuation formulas also ensures that you will not be overpaying for the business you desire.

About the Author

Richard Parker is the President and founder of the prestigious Diomo Corporation - The Business Buyer Resource Center. His celebrated materials, seminars and consulting have encouraged thousands of aspiring business buyers from around the World to pursue their dream of buying a business. Want to discover more about impressive business buying success strategies that really work, then look no further than=> http://www.diomo.com/

Article Directory Source: http://www.articlerich.com/profile/Richard-K-Parker/53039

Additional Articles From - Home | Business | Entrepreneurs