There are many options available
The question is really which one is going to work best for the business you are trying to put value on? That is just not an easy question to answer, so we are going to take it slow and walk through this one together step by step. I am sure you have heard all of these acronyms once or twice before in your life: EBIT, EBDT, EBITDA, and SDE. We are going to begn by describing each of these business valuation methods briefly, but you are going to need to keep a couple important thing in mind while we do. The methods take the actual reported earnings and then multiply them based on specific factors that are relevant to national industry sales stats. That means that the seller is going to need to be able to provide an accurate account of their earnings, something that is unfortunately quite rare when dealing with small businesses. Beyond that, it is ultimately going to then be depend on the person doing the final calculation to pick the appropriate method and thus the appropriate factor to use. This leaves the entire process open to a lot of ambiguity and uncertainty; both things which should be avoided at all costs when contemplating large business transactions.
SDE: Seller’s Discretionary Earnings
This is defined as the earnings of a business prior to the following items being deducted:
– Income Taxes
– Non-recurring income and expenses
– Non-operating income and expenses
– Depreciation and amortization
– Interested expense or income
– Owner’s total compensation for one operator
Earnings before interest and taxes.
Earnings before depreciation, interest, taxes, and amoritization.
Earnings before depreciation (and other noncash charges) and taxes.
Another way to do this
Complicated and quite convoluted, we know. So, what else can a regular old small business owner do to figure out how to price their business? You can use a rule of thumb based off of a multiple of gross sales. That is a number that anyone should be able to accurately track; even if the bookkeeping is atrocious. Just by physically observing a business for a specified period of time anyone can get a fairly precise figure to work off of; seasonal fluctuations being considered of course. Choose the option that makes the most sense for the business of interest but our personal recommendation is to use the last mentioned technique as it is most likely to be based off of valid financials instead of pure conjecture.