Business Valuation – Why the Asking Price of a Business Can Differ From the Actual Purchase Price

The other day I came across a social media site and noticed an old post. Someone was asking a question about how to value a business. Ten people were good enough to answer. I was not surprised when all 10 replied with completely different methods on how to value a business. You have to assume that people taking the time to answer the question were reasonably confident that they knew the correct answer. It made me wonder where they actually got the information from and how much confusion this subject creates with almost everyone including accountants and business brokers. I can hear you asking how to go about establishing the asking price of a business.

This is the method a Business Broker will use to determine the asking price of a business.

The method below is used by business brokers to determine an asking price for a small business; it is based on the adjusted net profit using the most recent profit and loss statements. The business broker will look at all the business expenses to see what they can add back to profit. This is referred to as add backs or recasting. The adjustment is made by adding back to the net profit all the non essential or discretionary expenses not necessary to run the business to show a more accurate net cash flow for the owner.

The business may also have unaccountable business expenses. A good example may be the rental expenses, if the business owner also owns the freehold and is only selling the leasehold you would need to ensure that the rental expenses are correct and adjust the profit if necessary, in this case it would be adjusted down.

Once this number is determined, the next step a business broker will take is to multiply the adjusted net profit, usually by 2.5 times, and they have an answer.

Let me give you an example of business broker method.

Business A; Established 12 years, trades 9-5 Mon-Fri with consistent sales, strong industry growth, selection of quality suppliers, and abundant customers etc.

Business B; Established 2 years, operates 7 days a week, sales are inconsistent, cut throat industry with aggressive competition, and it only has one customer.

Both businesses A and B show $100,000 adjusted profit after the owner operator wage is taken out. The business broker will then use the same multiple on both businesses i.e. 2.5 x $100,000 = $250,000. This will include stock, the written down value of the plant and equipment and the goodwill.

As you can plainly see this method does not make a great deal of sense.

As a business buyer or business seller it is important for you to never assume that the asking price of the business is anywhere close to the correct value even when it is set by so called professionals. You can be talking hundreds of thousands of dollars either way. Scary!

There is a better way. Have a look at this business valuation example available via the link in the resource box below and see why accountants are popping their cardigan buttons!

For more information regarding risk factors and analysis when Buying or Selling a Small Business, a recommended resource for expert, user-friendly, step by step Business Buying and/or Selling information and Small Business Appraisal Software Tool, go to Business Valuation Example

The Bizbuy Kit and Bizsale Kit are low cost and cover a myriad of tips, techniques and strategies – a vital resource. Plus, there is a comprehensive Small Business Appraisal Software Tool enabling the buyer or seller to expertly appraise a business multiple times.

The authors of the popular eBooks ‘How To Buy A Business’ and ‘How to Sell Your Own Business’ are experts in their fields of Business Buying, Selling and Business Valuation. With decades of experience buying and selling businesses of all sizes, they have seen many mistakes made by both buyers and owners. They have combined all their years of knowledge to deliver a low cost alternative for DIY buyers and sellers, stepping through the process thoroughly in order to avoid common mistakes and significant expense.