Small business owners all over the world usually fail to stop and ask themselves just what their business is worth until they are attempting to sell their business or preparing for retirement. However, gaining early perspective concerning the worth of your business from a third party can greatly benefit the future of your business goals and overall direction. If you are at the point of selling your business or planning for retirement, succession, or divorce, this simple question has no simple answer. Depending on what value is being calculated, a third party could conclude on a much different price when assessing fair market value versus another calculation like most probable selling price.
For the sake of simplification, only the most probable selling price method will be discussed here. Since you are probably hoping to determine the value of your company so you can sell it or pass it on to an heir, this is the method that will be determined. Three approaches can be taken, including market, income and asset approaches. Market approach is when your business is compared to similar businesses that sell the same goods or services and how much they were sold for. This cannot be the only approach however, as comparing businesses in different states that are different sizes from one another can throw off findings.
Income approach calculates how much money your business is generating for you on a yearly basis and determining a reasonable price it could be sold at. Since small businesses are a risk and not guaranteed to generate income, an accommodation must be made for the risk factor. Cash flow is identified through a process known as recasting which involves dissecting tax returns and determining how much money actually benefited the business owner. By following trends of past years, you can calculate estimated future returns the business will make for the new owner.
The final approach is called asset approach. Also known as cost approach, this method deals with physical assets but does not provide much value for goodwill. Many businesses place a good amount of emphasis on goodwill, meaning this would not be the best approach. However, if your business has a number of investments in outside sources, this could be a very beneficial method of determining how much your business is worth. As you prepare to put your business up for sale, understand that negotiations will undoubtedly occur and the market will be the ultimate determining factor of what you can sell your business for.