Business Valuation Formulas

So, you've examined your company's historical financial statements, thought carefully about your prospects for future growth, and perhaps had your accountant recast your statements to reflect how new ownership would affect your company's earnings and cash flow. You've also considered the market value of any real estate, equipment, inventory, and other hard assets that would be transferred in the sale, as well as the intangible aspects that make your business appealing.

But how do you boil all of this down into an asking price for your business?

Hopefully, you'll take our advice and hire an expert business appraiser to do this for you. The process can be very complex and time-consuming, and takes quite a lot of experience to do well. There are a number of valuation methods that business appraisers have at their disposal, and even choosing the correct method (or more likely, the correct combination of methods) to use in a given situation can be considered more of an art than a science.

Here's a rundown of the major approaches commonly used to put a price tag on small businesses. We're not going to overwhelm you with details, since a lot of variables, mathematical formulas, etc. come into play with virtually every method. Our objective here is simply to give you a feel for the process that your appraiser will be going through.

Business valuation methods fall into the following categories, depending on what their major focus is:

• business assets, including book value and liquidation value methods
• historical earnings, including debt-paying ability, capitalization of earnings or cash flow, gross income multipliers, and dividend-paying ability methods
• a combination of assets and earnings, namely, the excess earnings method
• the market for similar businesses, including comparable sales, industry rule of thumb, and p/e ratio methods
• future earnings, namely, discounted future cash flow or earnings methods

Although no substitute for an appraisal and valuation by qualified professions, the Interactive Business Valuation Calculator can provide you with a rough idea of the value of your business.