- Valuing a business relies on some established rules of thumb.Robert Kirk/Photodisc/Getty Images
Determining the value of a business is not an exact science. However, the process relies on several generally accepted principles of valuation that serve as rules of thumb. In order to buy or sell a business at its fair market price, it's important to retain a professional business valuation expert. - Value your business now, even if you have no plans to sell it, advises small business consultancy SCORE. If you want the business to survive beyond its current ownership, effective planning for a transition of ownership requires an accurate valuation that is kept current.
- Understand how the Internal Revenue Service values a business, says SCORE. The fair market value (FMV) is the price a buyer will pay a seller when both parties are fully informed and under no pressure to act, reports SCORE. Although the value of your business might be presented in a price range, the wider the range the less reliable the valuation -- and the more likely it will get extra scrutiny from a prospective buyer.
- Learn the rules for so-called "earnings multipliers." The earnings multiplier is the best method for valuing a business, according to BizBuySell. The key consideration is which earnings to multiply. For example, for a new enterprise, a sale price could be figured from its first-year earnings. For a more established company, the valuation might be based on earnings over the past 5 or 10 years.
The earnings multiplier you use will vary based on your industry and its relative degree of risk In some instances, the multiplier could be as low as two or three. In other instances, it could be as high as six to eight -- or more. In general, multipliers are higher for businesses that already have customers and revenue, as opposed to an enterprise that promises market-altering innovation, but has no customers or revenue yet. - Use "earnings before interest and taxes (EBIT)" to determine the profits from the business, according to BizBuySell. EBIT is the method that accountants typically use, so it is a widely accepted metric for calculating the real "bottom line" of any enterprise.
- Sometimes, related assets such as inventory, equipment or real estate are proposed as part of the valuation, usually by the prospective seller. The test for whether a particular asset should be included is whether it contributes directly to the generation of reported earnings. If it is required for the ongoing performance of the organization, it should be included in the business valuation.
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