02:01
Faizan
The first question that comes into the mind of businesspeople when they decide to sell their company is - how much is the company worth. There is no straightforward answer to this question. Different experts might end up with different selling prices of the same company based on the books and the many variables (many of which are subjective) that are involved. However, there are a few generally accepted rules of thumb and techniques, which are discussed in brief in the following part of this article.
For a small business, its price can be estimated in two major ways. The first method involves the ability of the company in generating sales, profits and cash flow. The second method is based on the value of the assets that the company owns. Methods are chosen depending on industry the company belongs to and its condition.
Using annual sales to determine how much the company is worth
Some of the industries like radio stations, PR and advertising agencies, consulting firms, insurance brokers, retailers and professional practices use a multiplier of its annual sales to determine the value of the business. The multiplier however is dependent on the several factors including the predictability of the sales and the business type. The starting point is the industry multiplier which can be further modified and adjusted depending on the company specifics. For example: for company A the industry multiplier might be twice the amount of annual sales, but the company experienced a strong and consistent growth during the past few years. This consistent growth might push the multiplier at a higher level to 2.75 or even higher. The opposite is also possible. A higher perceived risk for the company might bring down the multiplier to 1.75 or lower. For a company that has few assets, little retained earnings and low fixed costs, the sales multiplier is the ideal technique to value the company.
Using cash flow or profits to determine how much the company is worth
Under this technique, the price of a company is based on its ability to generate profit or cash flow. The seller uses the stream of cash that is expected to be generated over the next few years (for example 5 or 10 years) to estimate what the business is worth. The future earnings are often discounted based on projected interest rates and thus takes into account the time value of money that is how much a dollar received in the fifth year is worth today. This method gives raise to disputes regarding the cash flow calculations.
For a small business, its price can be estimated in two major ways. The first method involves the ability of the company in generating sales, profits and cash flow. The second method is based on the value of the assets that the company owns. Methods are chosen depending on industry the company belongs to and its condition.
Using annual sales to determine how much the company is worth
Some of the industries like radio stations, PR and advertising agencies, consulting firms, insurance brokers, retailers and professional practices use a multiplier of its annual sales to determine the value of the business. The multiplier however is dependent on the several factors including the predictability of the sales and the business type. The starting point is the industry multiplier which can be further modified and adjusted depending on the company specifics. For example: for company A the industry multiplier might be twice the amount of annual sales, but the company experienced a strong and consistent growth during the past few years. This consistent growth might push the multiplier at a higher level to 2.75 or even higher. The opposite is also possible. A higher perceived risk for the company might bring down the multiplier to 1.75 or lower. For a company that has few assets, little retained earnings and low fixed costs, the sales multiplier is the ideal technique to value the company.
Using cash flow or profits to determine how much the company is worth
Under this technique, the price of a company is based on its ability to generate profit or cash flow. The seller uses the stream of cash that is expected to be generated over the next few years (for example 5 or 10 years) to estimate what the business is worth. The future earnings are often discounted based on projected interest rates and thus takes into account the time value of money that is how much a dollar received in the fifth year is worth today. This method gives raise to disputes regarding the cash flow calculations.
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