How do you value a business?

[3 MORE YEARS]

I have very little knowledge in business sale and valuation. I am just looking for a very general guide on valuing a business. I read somewhere, that a simple rule is 5 times the business turnover. So, let's say you had a business that had no debt, no major overheads, and very little stock, let's say it was a knowledge based industry like "Accountancy" or "Graphic Design" or "IT Support Service", and let's say it was getting 10 new customers walking through it's door every day. So if that business had a turnover of £100K, using simple numbers, would it's business value be around £500K?

I realise business value's can be complex etc. But I am looking to use a very simple formula to get a general idea of value.

Thank you.

 

[vvaannmmaann]

It's only worth what you are willing to pay for it.

 

[Bob]

I would find it hard to think of a normal business worth 5 times turnover. Accountancy 5 times turnover - I wish
Interesting article here

 

[lww]

5 times turnover is not a sensible metric, not least because different business models work on different gross profit margins. As Duncan Bannatyne would say, "turnover is vanity, profit is sanity".

I would suggest that as a decent rough guide for a small or medium business, you would not be a million miles away with 3 x net profit plus current assets. Obviously there are many other variables, and it will only ever be worth what someone wants to pay for it but that's a starting point - why not look through websites like Turner & Butler or BusinessesForSale where you can see a multitude of businesses for sale which show turnover, profit and asking price... you will soon spot the delusional ones!

 

[lawyerfair]

every business is individual when it comes to valuation - two businesses that look on the surface very similar, might have very different risks in the eyes of a buyer i.e. type of clients, are those 10 customers delivering one off purchases or turning into longer term clients? are there any contracts in place? what are the liabilities of the company? is there something nasty lurking on the balance sheet? is the business overly reliant on the owner? could the revenue drop off a cliff the moment that business is sold? these are the calculations taken by a buyer in assessing what they will pay. they will also asses and value very differently a business that provides them with a strategic premium.

using transfer agents or online sale website valuations as a guide is likely to end in tears as many valuations - particularly of smaller businesses - are bonkers.

even profit multiples are variable depending on sector, size of business and the factors listed above. the profit of a small business is highly vulnerable, compared with more established business, and therefore the profit multiple is likely to be pretty low.

if looking to sell, concentrate on getting the business well prepared and finding a strategic buyer.

if looking to value for other purposes, bring in a valuation expert, preferably someone with experience in your particular sector.

 

[MOIC]

Too many factors involved to give a "guideline".

Every business has a unique set of circumstances as well as the potential purchaser.

 

[SwissChris]

On a very basic level

All assets minus all liabilities. That's the easy bit.

The tricky bit is working out what premium you want to pay to secure the future cash flows of the business.

I consider the cash flows to be the net cash generated by the business after all expenses are covered, including owners wage if they are active in the business

Example: (I'm loose loose with the specific terminology)

Business turns over £250K p.a. and makes a profit of £35K after all staff, suppliers and HMRC are paid. The owner needs to survive so has £30K of that leaving a £5k net cash position.

The business should be valued on the £5k output not the £35K. The question being what would you pay to secure a £5K a year perpetual income stream?

You need to consider the assets, liabilities and turnover to gauge the value of the proposition. Is it making £5k p.a. on £1m worth of assets - if so why so little? Is it making £5k against no assets - if so how and why?

It's all about weighing up the value in the proposition.

Just make sure you are not buying yourself a job, you can get one of them for free!

 

[Chinavasion]

Valuation is a complicated practice. There are companies out there that haven't made a penny in the last few years, but are worth a fortune. For example: Twitter.

You can make it super complicated and build a whole excel valuation model on it by using the concept of net present value with different growth predictions. But this is something investment bankers use to convince investors.

To keep it simple for small businesses, people usually look at a multiple of the annual revenue and/or profit. To determine what the multiple is reasonable, the best way is to look the valuation of similar businesses.

 

[CharlineCaisse]

I had no idea till I read a couple of the posts here!
But I am really curious about it!
I work for the small inventory company www.ticktickcheck.co.uk and now I wonder if I could do an estimate evaluation. I have access to most of accounting information. There should be some kind of formula, right?
% of turnover + % of all assets and so forth + % of profit + growth % maybe? I couldn't find anything close to a definition on the web..

 

[uksme]

Hi 3 MORE YEARS, the multiple-of-earnings ratio will differ significantly depending on the size and the type of business. For instance, the following figures show the averages for IT & Computing Services businesses for sale on our website (the UK's largest business for sale marketplace):

• Average asking price: £179,353
• Average annual turnover: £433,797
• Average annual profit: £186,694

As you can see from the above stats, the average asking price is less than 1x turnover, but these numbers change significantly on a case-by-case basis.

Please feel free to browse our business for sale directory to get a sense of what other businesses on the market are currently asking. If you can see the asking prices of a few businesses similar to your own, this might give you a better sense of the correct value, rather than following a specific multiple of earnings.

Hope this helps

 

[The Byre]

Swiss Chris has given an excellent answer. The only things I can add to what he has said is

1. A job is worth something. Yes, we can get jobs for 'free' i.e. go to work for somebody else, but there is some value in have your own place of work, albeit not as much as some people imagine!

2. You have to factor in the future. A DVD production line may be on the books at £5m, but the days of the DVD are rapidly coming to an end, so a small fraction of that would be the real figure.

 

[swankypants69]

Its also important to consider the question "what would it cost me to start the business from scratch"
And perhaps more importantly, how secure/unique is the business ie. what is stopping someone opening up next door, doing exactly what this business does

 

[Chinavasion]

• Average asking price: £179,353
• Average annual turnover: £433,797
• Average annual profit: £186,694

Hope this helps

The asking price looks to good as you can earn it back in 1 year. These are very tricky numbers. When displaying such stats it's better calculate thee average ratio of Annual_profit/asking_price and show the average of that.

 

[deniser]

SwissChris touches on it briefly but the general and very basic rule is that the more the business is dependent on the person running it, the lower the value.

For service based one man businesses such as the OP describes - buying yourself a job essentially - the value is very roughly 1 x annual net profit.

But for businesses which can be run by anyone (without any particular qualification or expertise) because they are fully staffed or because no particular skills are required, the value can rise to 2-3x or more the net annual profit.

 

[CharlineCaisse]

It is the "law of relativity"..
Just what I thought..
There is no particular formula or at least a set of rules on how to evaluate a certain business or company..

 

[Talay]

All these figures are cobblers because they are only made up profits figures (agents never check that numbers given them are real), valuations (often extrapolations of made up weekly turnover) and not actual sales prices (which are fractions of the "headline" asking prices) and many never sell in any case or fall off radar.

The only way to get to the truth is to go through the buying process and get accounts (many are again fraudulent, VAT avoidance scams due to separation of enterprise or have X percentage paid in cash etc.) and watch how perhaps 90% of vendors fail to get back to you with the required information once they know you are asking questions they can't or don't want to answer.

I look at deals every day and dismiss 99% or more. Even most of the 1% never see the light of day because there are inconsistencies in the financials. QED valuations are very hard to assess.

 

[Fred_the_frog]

I have very little knowledge in business sale and valuation. I am just looking for a very general guide on valuing a business. I read somewhere, that a simple rule is 5 times the business turnover. So, let's say you had a business that had no debt, no major overheads, and very little stock, let's say it was a knowledge based industry like "Accountancy" or "Graphic Design" or "IT Support Service", and let's say it was getting 10 new customers walking through it's door every day. So if that business had a turnover of £100K, using simple numbers, would it's business value be around £500K?

I realise business value's can be complex etc. But I am looking to use a very simple formula to get a general idea of value.

Thank you.

Look at it this way, two companies- Company 1: Turnover £100k, Net profit £60k. Company 2: Turnover: £100k, Net loss £30k. Would you pay £500k for both?