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When a client asks this question, it can sometimes be a little hard to tell whether or not they are trying to be sarcastic. Are they trying to imply that there business is not worth anything or something else? More often then not, entrepreneurs are simply uncomfortable putting an actual bottom line figure on their business. Some are currently contemplating selling while others may be going through the motions out of pure curiosity. Either way this exercise can produce some useful results.

Hard work does not necessarily directly translate into true value. No matter how hard you squeeze you are not going to be able to turn coal into a diamond; your hands will get bruised and it will be a good work out for what that is worth. It can be difficult to realize that it does not matter how much effort you had to put into it in the past, how much you struggled or how far you have come. All that matters is the perceived value to a new potential buyer and if they can not see it with their own eyes then they most likely are not going to see any value in it either. Let go of the past and forget about the future, keep focused on what you currently have in operation instead of telling stories or selling dreams.

Owning and running their own business is what keeps a lot of people going day to day; without it they do not know what they would do. But, whether you like it or not, life has a way of throwing you a curve ball every once in a while. No matter what you do to prevent it there may be a time in which you are forced to sell your business. The last thing you want to do in that situation is sit around scratching your head as things fall apart, no it is much better to have a well thought out plan ahead of time just in case. That all starts with putting a proper valuation on the business.

Although this guide will help you to put a basic small business valuation together by yourself, it is always recommended that you take this one step further and consult with a professional afterwords. They will have a number of other resources available to assist you such as comparable reports to see what similar business are selling for in the market place.

There are many financial factors that need to be considered when performing a business valuation, but the sad truth is that in the real world these are often all over looked. New business owners tend to buy businesses based off of their personal feelings above all else, using flawed reasoning in hindsight to justify their purchases. Needless to say this is not the best strategy and can in fact end up costing someone their lives savings. As flawed and ambiguous as it may be, it is much better to use some sort of standardized mathematical formula to put a basic figure on the assets.

Yes, many experts are going to tell you about multiples and factors plus add backs etc. In a perfect world, these are all valid ways to figure out what a business is worth. In reality, most small business owners do not track their sales or expenses very well, living out of the cash register so to say. What to do then? Figure out a method to calculate the average number of customers per day and the average spend per customer to put a very loose number on the annual gross sales. As far as the expenses go, try collecting every single bill that you can for several months to average those out. Some may be sporadic while others are reoccurring monthly, no matter what you do if things are not organized there will always be expenses that get overlooked.

The inventory needs to be accounted for and factored in, it is obviously only fair to do so at actual replacement cost and not retail pricing. With aged inventory it can often be difficult what it is actually worth, and any such considerations need to be handled carefully as they can have a huge impact. Property is easy enough to handle as there will always be similar type properties for sale that you can use as comparables. Remember to adjust for condition and any repairs that will be needed immediately. The equipment can be a little difficult to price, just as the inventory. Place a few phone calls to local dealers that specialize in used equipment to get a real idea of what things are going for. Ebay or Craigslist can also be great resources for you for this part of the valuation process. Any outstanding liabilities are subtracted from the value of the small business, it is as simple as that.

Now for the fun part, a “real life” example to look at. Dear old Sally has decided it is time to sell her quilting business and no one knows how she manages it but the business has not inventory, assets, or liabilities. She sells an amazing $200,000 annually and has $150,000 in business expenses going out. Upon closer inspection it appears that Sally has a few items included in the business expenses that could be classified as personal, such as a business trip to Hawaii and professional jewelry purchases totaling $20,000. This practice is frowned upon by the IRS and in no way endorsed, but regardless it needs to get added back in to figure out the net income. If someone was to buy the business and run it just the same as Sally did, they would be able to make about $70,000 of profit every year. If the buyer does not intend on running the business themselves, but is planning on hiring someone else to do it, then they need to subtract that projected salary amount from the previous number to get the calculated free cash flow.

1) Where has the business been and where is it going?

You can apply the same basic steps we ran through above to any business that you may be considering purchasing or selling. From there, take a look at the free cash flow over the last few years to try and spot any patterns. Each time it takes a turn, make it your goal to figure out or explain why. Maybe there was a change in staff or a family emergency. Whatever the cause may be try to get a clear picture and to then verify the facts with documentation whenever possible. Potential buyers are going to understand exactly what is going on and if it is negative how they can both turn it around and prevent it from happening again. If that free cash flow is going up, many people assume this means that the business is going to continue growing indefinetly. This is simply not the case as there is always going to be some sort of ceiling or point at which further growth would not make sense. Each industry has a finite number of customers that it can serve, and there is always a quantifiable tipping point at which it would cost more to acquire more customers then the potential profit that could be earned from them. The numbers moving upwards are a good sign, but paying a 10X multiple is not always the best advice.

2) How Risky Of A Purchase Is It?

Risk comes in all different types of shapes and forms. Sometimes it is hard to see and other times you can not miss it no matter how hard you may try. There are certain staples that we will always need as consumers, and although the related businesses and industries will each have their own positive and negatives aspects to them, we can none the less classify them as stable. Fringe and trendy business are risky because they operate in untested environments, while certain other business are risky because of the inherent dangerous services that they offer. Marijuana business are good examples that fit well within the fringe category while tanning salons were once the hottest business around, and now you can not give them away. Roofing companies are risky because the work they perform is dangerous, contractors can fall off a customers house and die while installing shingles.

Current staff quality is a major contributor to the overall value of a business but it may also be one of the hardest to accurately pin down. Resumes are great tools as are personal interviews but all of that can be manipulated. It is tough to say, but you are going to have to rely on your gut instinct here. A lot of the conclusions can be considered personal opinion and nothing more, and regardless of what you may know about an employee you can not say how they are going to end up reacting when there is a change in ownership.

Any policies, procedures, or technology that is in place to improve staff efficiency, automatically track business data, and prevent theft is a major plus. Even basic camera and POS systems are a starting point that can be easily upgraded. The most important part is that the staff is used to having and using these systems in place so the new owner is not going to have to retrain them or overcome and objections that they might have to the implementation of anything new.

3) What are other business in this area selling for?

If your business is fairly common, then you may actually have some valid stats available to use as comparables. Many of them might be based off of national stats, but there are great resources available that are capable of collecting enough sales data to produce statistically accurate rules of thumb to use. Spend some time researching the topic online, or order yourself a book such as the one found here. You can also snoop around the local classified ads, Craigslist, or BizBuySell to get a general idea, but always keep in mind that these are just asking prices. What a seller wants to sell their business for versus what they actually end up taking is a big difference. That, and with only 1 out of 3 business on the market even selling, the last thing you want to do is scare away any potential buyers.