Valuing a Business

Last Updated: August 22, 2009

Chapter 6: Valuing a Business

Arguably, a business is worth what-ever someone is willing to pay and therefore will vary from person to person.

Today, there are over twenty different ways of valuing a business and this is why many people cumulate different prices. The price that the seller asks for is almost never what they will receive and is usually reduced in value through negotiations between themselves and you- the buyer.

It is important that you value the business yourself (with the help of assistance) so that you can be sure that you are not over paying for a business.

By paying too much, you will encounter further financial problems if the business doesn’ t turn out to be successful. On the other hand, those businesses that do prove successful will serve justice to the amount you paid.

In most c ases, a business should be valued against the ability it has of generating a good cash-flow. In other words, the price will be dependent on the level of consistency the business has at making profits. All businesses are unique and therefore it is important that you use the most appropriate valuation method to determine a realistic value.

6a) Be Aware!

There are many people out there who use the wrong valuation methods to price a business and consequently pay too much. To give you an idea, look at a couple of them – the first of these is the Comparison Approach:

Say a small business has a Net Profit figure of £5,000 a month and was sold for £200,000 and the business that you want to buy also has the same Profit figure. You would be wrong to think that because they have the same Profits, they should both have the same value. The business that was sold for £200,000 may have only been operating for a few months and therefore, chance is that the profits are likely to increase.

The business you have interest in may have been running for a number of years and profits may have stabilized. Also, that business may have a shorter operating period, say, five days a week, compared to your potential business’ operating period of six days a week. The moral is that you should never compare prices to businesses with similar profits.

Quite often, many people have confidence that the seller has provided a realistic value and therefore they try to make a bargain by reducing this price by say, 10%. The trap that you may have fallen into here is that the seller may have inflated the price anyway in an attempt to make a bit more money out of the deal. So in theory, you haven’t made anything from using this approach and consequently will have paid the price that the business is worth or maybe even more.