Deciding the price for an existing business can be very challenging. The parties to the agreement may have varying opinions on what the fair value for the business is. Every party will be right on their own accord. In most cases, the party which is the least prepared for these negotiations will make the biggest compromises.
Keep in mind that a business that is up for sale will determine their rates arbitrary or through a special technique that is only used in that particular industry. Despite these varying opinions, there is always solid facts that the parties can use to reach an amicable price.
Getting the specific price may be hard at fast. There are so many factors that will influence their prices. Such include the prevailing market rates among others. The businesses will fetch higher rates when the economy is expanding. The rates will be lower when the economy is on a recession.
Personal factors may also influence the price you pay for a business. The owner who is in financial distress may settle for a lower rate than they would have if they were financially stable.
These are some common methods you can use to determine the value of a business.
Here, the owner will calculate the value of their enterprise using a specific multiplier. They may use these variable to arrive at the best rate: the monthly gross sales, after-tax profits or the monthly sales plus inventory.
At first, the multiplier looks quantitative and very accurate. However, once you look at the specifics closely, there will be little to substantiate when arriving at this price.
As you will find out, most multiplier equations won’t be based on facts. For instance, any price arising from the use of after-tax profits is likely to be inaccurate. Remember, most companies will not disclose their profits for tax reasons.
- The Book Value
The method is fairly accurate in the exercise. However, you need to be very cautious to arrive at the right price.
Using the book value to ascertain the net worth requires you to subtract the liabilities from its assets to get the net worth. You can easily do this from the company’s balance sheet. This also takes into account the location of the business. For example, if you are looking at businesses for sale in Michigan, these may be valued lower than in areas where the cost of business is higher.
At first, this may seem simple enough. It only requires you to get the assets and liabilities figures correct. Determine their net worth and multiply with a given number to get the price.
However, you need to ensure you get all the assets and liabilities correctly. The only challenge here is that all assets are listed in the balance by their depreciated value. The figure may be different from the replacement value. So, what would happen if the assets have been in existence for years and they’ve been depreciated to zero? Well, you won’t have anything to base your valuation on.
- Returns on Investment
This is the most common method of evaluating existing businesses. It shows the amount of profit a buyer will benefit from after servicing debts and taxes.
However, don’t confuse the ROI with profits. Profit helps measure the performance of an entity. The ROI is the entire amount that was invested in the business, and how much was made off that investment.