Determining the Value of Your Business

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Some business owners find it difficult to accurately assess how much their business is worth. After all, how do you place a dollar value on the years of hard work, dedication and passion you have poured into your company? But like it or not, eventually you are going to be forced to quantify the value of your business.

There are a number of ways you can do this. Here are three of the most common ones.

Rule of Thumb Method

The rule of thumb valuation method determines the value of a company based on its ability to generate profit during a specified period of time. Here's how it works: Start by determining your business' net profit (gross income minus expenses) before interest and taxes have been paid.

Next, multiply that figure by a "multiplier" — typically 3, 4, or 5. The multiplier is based on the number of years it will take a new owner to earn back his/her investment. So for a business that has a lot of assets, it is more appropriate to choose 5 as the multiplier because it will take longer to pay off the investment. For a business with relatively few assets, a multiplier of 3 would make more sense.

Asset-Based Method

Another common valuation method uses the value of the business' assets to determine the dollar value of the company. While an asset-based valuation method is not useful for every small business, it works well for retailers, manufacturers, wholesalers and other companies that regularly own large quantities of fixed assets — i.e. equipment, inventory and overhead.

The usefulness of an asset-based valuation method depends entirely on your ability to accurately determine the Fair Market Value (FMV) of the assets. The FMV represents the amount of money it would cost to replace the equipment at current market prices and inventory at wholesale prices. To accomplish this, you may need to employ the services of a professional business appraiser or tax consultant.

Once you have determined the value of your assets, an "owner benefit" value (an intangible figure) is added to the FMV to calculate the worth of the business in real terms.

Industry Average Method

The industry average valuation method estimates the total worth of your business based on the sales price of other businesses in your industry over the past six to 12 months. This method is somewhat less precise than the other methods because no two businesses are exactly alike.

Each business has variables that make it more or less valuable than its peers. Factors such as location, size of the customer base, company reputation, market share and others can make your estimate more accurate, but in the end it is simply an estimate. For that reason, this method is often used to produce a range of values during discussions between the buyer and seller.

Ultimately none of these valuation methods offers an absolute and definitive value. Like your house, the true value of your business can only be determined by how much someone is willing to pay for it. Until then, decide which of these methods makes the most sense for your circumstances and go to work.