Small business owners invest a lot of time and emotion into establishing and building their business. But surprisingly, not many owners know what their business is actually worth!
Whether you’re looking to sell your business in the next 6 months, 2 years or when you retire, its important to have an understanding of its value. Understanding this figure, will help you grow your business and make sure your accounting is up to date. When it comes time to sell, buyers want to see a solid history of the accounts and continued growth.
How is a business’s worth calculated?
There are a few methods to obtaining a valuation for a business. There is the financial valuation that looks at the turnover, net profit, equipment, stock, and potential growth of the business to determine its price. Then there is a market valuation that analyses similar businesses in the area and makes a comparison to determine what the business may sell for (e.g what was the sale price of a similar 20 seat café down the road). Often owners/brokers/accountants will use a combination of these two methods to determine a sale price.
With a financial valuation, it is common for business owners to value their businesses based on earnings multiplied by a factor, normally between 1-3. For example if a business owner earns $100,000 and they feel their business is worth 2.5x that, they will value it at $250,000. There are a lot of variables that go into the multiplying factor, such as; age of the business, industry, size, competition and sales history. The more stable a business is, the higher the multiplying factor.
The best way to value a business is to speak with a licensed business broker or accountant to get a proper understanding of your business and the current marketplace.
It is estimated more than 50% of business owners have an inflated view of their businesses' value and between 25-30% have an undervalued view (Chief executive and founder of Succession Plus Craig West, SMH.com.au)
What are the 2 most important aspects that impact a business valuation?
1. Owners Salary
The business may have a high turnover, but is the owner actually earning a wage? Once the businesses expenses are taken out, what do the figures show? A business may have been running for 30 years but if it has no drawings or net profit, it isnt very enticing to potential buyers and will impact your valuation. Business Owners need to ensure the accounts are being entered correctly and kept up to date.
2. Level of Risk
Is your business stable? This can come down to many factors. Such as, does your business have a long lease? If the lease is ending soon this can greatly affect the price someone is willing to pay. Changing a businesses location, can affect the client base especially if reliant upon walk by traffic such as a café or takeaway store. Ensuring your lease is for an extended period can enable a good price for your business.
Another question of risk, is does the business have longevity? Will it be relevant in the next 5-10 years? Many industries are becoming high risk due to technology advancements, cheaper competitions from major retailers and online stores. Retail stores such as video stores, homewares and toy stores are finding it harder to compete with these changes. If your business is becoming high risk, what can you do to reduce this risk? Perhaps starting an online store or social media presence will help reduce the risk factor in your business.
It is important to have a solid understanding of your businesses value so you can plan for the future and forecast. There is nothing worse, then needing to sell your business and not having your financials prepared properly. Buyers want to see at least 3 years of solid financials. Talk with your accountant and make sure you are in a good position, should you ever wish to sell your business.