Appraising a Business
Putting a price on a business is as much an art as a science. While there are some standardized formulas to calculate value, assumptions are made based on industry benchmarks, risk and return variables, and comparable sales of similar businesses within the same geographical location. In short, the value of a business is based on three things: what it owns, what it earns and its risk versus return.
What it owns
A business owns tangible and intangible assets. The tangible assets are the furniture, fixtures, equipment, inventory and real estate. The intangible assets can include the trading name, contracts, leases, processes, client lists, licenses, recipes and patents.
What it earns
The business owner derives certain financial benefits from owning a business. The benefits generally come in the form of business profits and a salary for the owner. The business can also provide the owner with fringe benefits such as health insurance, a company car or a retirement plan.
Risk versus Return
Every investment has a perceived level of risk and an expected rate of return. In determining the goodwill component of the business sale, the likelihood of future income and the replicability of current income are quantified.
Beware of “Rules of Thumb”
There are many different rules of thumb available, but in most cases they do not give an accurate value of a business because they are based on an “average business.” Even though most industries have one or more such rules, there are not any “average businesses.” Each business is unique and a particular rule of thumb can be off by as much as 100% or more. A business broker will be able to advise what information is most relevant to the business and then provide a range of its market value.