Introduction to Business Valuation
* 6) Sellers Discretionary Cash Flow
* 7) Asset/Earnings
The Market Approach
is defined as: a general way of determining value of a business or an equity
interest in a business using one or more methods that compare the subject
to similar investments that have been sold, and then applying appropriate
units of comparison and making adjustments based on the elements of comparison,
to the sales price of the subject comparables.
THE MARKET APPROACH:
* 1) Market Comparable
(used for larger companies)
or Direct Date Method
(used for smaller companies)
* 2) Rules of Thumb
COST OR ASSET
The Cost or Asset Approach
is defined as: a general way of determining a value of the business's assets
and/or equity interest using one or more methods. The assets valued under
this approach will include all current assets, tangible and intangible operating
assets and non-operating assets, however, goodwill and other related intangible
assets are not normally included.
THE COST APPROACH:
1) Net or Adjusted Asset
2) Liquidation Value
3) Cost to Create
THE INCOME APPROACH
The Income approach
requires the development of some form of "capitalization" or "discount"
rate and refers to the conversion of anticipated benefits into value. Many
Business Appraisers and Accountants use "quantitative factors"
to determine the capitalization rate of the subject company, others, including
business brokers often use " qualitative factors", some use both.
Typically, capitalization rates can run 10% for a low risk business, 20%
for a medium risk business and as high as 30% for a high risk business.
Generally speaking, the higher the capitalization rate, the riskier or less
desirable the business. The equivalent percentages to the above multiples
would be 5 = (20%) , 3.33 = (30%), and 2.5 = (40%). or simply divide 1 by
the capitalization rate to determine the multiple.
AND JUSTIFICATION OF PURCHASE PRICE
For the three primary
requirements for a good business, remember the 3R's:
(1) Provide a Reasonable
Salary to the new owner
(2) Must produce enough
cash to Repay Debt service to seller
(3) Provide buyer with
a reasonable Return On Investment.
RULES OF THUMB
" Rules of Thumb
may be self-fulfilling prophesies, the more one is used, the more people
are willing to accept it."
Jeff Wright, Author,
"What a Business is Worth"
" A Rule of Thumb
is a market-inspired pricing tool, based on collective feelings of those
in the business or closely associated to it, that indicate what a business
should sell for or could be purchased for."
FOUR TYPES OF RULES
*1) MULTIPLE OR % OF
*2) MULTIPLE OR % OF
*3) UNIT MULTIPLIER
- "X" dollars per patient, client, patron, student, etc.
= "X" dollars per prior year burials
Agency = "X" dollars per available automobile
= "X" dollars per restaurant seat
*4) MULTIPLE OF EARNINGS
OR SALES PLUS ASSETS OR
% OF EARNINGS PLUS ASSETS
* Values calculated
under any of the above types usually do not include inventory
NOTE; VALUES CAN BE
SIGNIFICANTLY DIFFERENT BY GEOGRAPHICAL REGION
RULES OF THUMB
AND THE EXPERIENCED BUYER OR BROKER
Some experienced buyers
and brokers will rely heavily on " SALES " rather than on "profits"
simply because that are familiar with industry Cost of Goods Sold, occupancy
costs, etc. Experienced buyers can quickly calculate their " true net"