Once you start thinking about selling your business, the first step in the process of selling your business is to determine the value of your business. There are many methods to help determine the value of a business. These include Asset valuation method, Return-On-Investment valuation method, Discounted Cash Flow valuation method, Capitalization of Earnings valuation method, Book Value valuation method, Market Value valuation method and several others. Asset based valuation methods value profitable businesses much lower than profit-based valuation methods.
The methods that are based off the profitability of the business are most commonly used when we are valuing a business to sell. The reason for using valuation methods based off profitability is because the business has a proven profitability, and these are the methods buyers and the bank will use for business transactions. In most cases profit based valuation methods derive a higher selling price when compared to asset based valuation methods.
Take an example of two businesses that manufacture the same product or provide the same service and own the same amount of assets. The only difference between these two businesses is the level of profitability.
If you used an asset based valuation method, like book value or asset value, these companies should be worth the same amount. If you base the valuation off profits the businesses would be worth much different amounts.
Company A is a small company that only makes $200,000 a year in profit. Company B is a larger company that makes $1 million a year in profit. If you use a profit based valuation method, Company B will sell for much more than Company A. If fact, Company B might sell for 6 to 8 times more than Company A.
If you’re thinking about selling your business now or in the near future, it is a good time to start the process and get an idea of what your business is worth.