An Introduction to Business Valuation

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* 6) Sellers Discretionary Cash Flow

* 7) Asset/Earnings

MARKET APPROACH

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.

METHODS UNDER 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 APPROACH

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.

METHODS UNDER THE COST APPROACH:

1) Net or Adjusted Asset Value

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.

FEASIBILITY 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."

Tom West

FOUR TYPES OF RULES OF THUMB

*1) MULTIPLE OR % OF SALES

*2) MULTIPLE OR % OF ADJUSTED EARNINGS

*3) UNIT MULTIPLIER - "X" dollars per patient, client, patron, student, etc.

Funeral Directors = "X" dollars per prior year burials

Automobile Rental Agency = "X" dollars per available automobile

Certain Restaurants = "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"