Business valuation is the process of calculating what a business is worth and could potentially sell for. To make sure you maximize your payout when selling your business, it is always recommended to work with an experienced business broker or valuation provider to sell your business for the right price.
For every business owner curious about the current value of their business, this article seeks to enlighten you with the tools needed to calculate the value of your business for 2022.
How To Value A Business Yourself
You can calculate the value of your business manually by following the three steps below, or taking the seller’s discretionary earnings (SDE) and applying an industry multiple. This is a simple and appropriate method that can be appropriate to value most small businesses. Other business valuation methods assuredly exist in today’s world which may be more appropriate depending upon the complexity and structure of the target business.
Be advised that completing a business valuation on your own can be complicated, and the results may not match the actual price the business sells for. It is always suggested to consult a professional business broker regarding a business valuation. That said, to appease all those who must have a 2022 estimate regarding the potential value of your business in a sale, read on for further information regarding estimating the value of your business based on your industry, current sales, and current profit.
As promised, the three steps to determine the estimated value of a business are:
- Calculate Seller’s Discretionary Earnings (SDE)
Most experts agree that the starting point for valuing a small business is to normalize or recast the business earnings to get a number called seller’s discretionary earnings (SDE). SDE is the pretax income of your business before non-cash expenses, owner’s compensation, interest expense and income, and one-time expenses that are not expected to continue in the future.
Small businesses often report expenses on their tax returns with an eye toward reducing their tax burden. This means that businesses regularly claim many deductions to lower their business income calculation stated on their tax return. For this reason, using income numbers from a business tax return can underestimate how much revenue the business actually produces.
Sellers’s Discretionary Earnings (SDE) gives you a better idea of the true profit potential of the business by calculating what the business earnings would be with a new buyer. This is done by adding back in expenses listed on your tax return that are not necessary to run your business. This includes your salary as the business owner and any one-time expenses that are not expected to recur in the future.
Items that are added to net income to calculate SDE include:
- Your salary, or total salary of all owners
- Any perks you or other owners receive (like personal travel or personal vehicle payments)
- Family members on payroll holding non-essential positions
- Non-cash expenses such as depreciation and amortization
- Leisure activities, such as business golf outings
- Charitable donations
- Any personal expenses, like the purchase of a personal vehicle, that were noted as expenses on the business tax return
- Business travel that is not essential to running the business
- One-time expenses that are unlikely to recur after the sale of the business, such as the settlement of a lawsuit.
In order to get an accurate valuation, it is important that key figures such as those listed above are factored into the equation.
- Find Out Your SDE Multiplier
Businesses typically sell for somewhere between one and four times their SDE. This is called the “SDE multiple” or “multiplier.” Think of the industry standard multiplier and the specific business multiplier as two separate numbers – one giving you a general value based on industry averages and another giving you a more specific value based on variable factors of each individual business.
Some of the factors that make finding the right SDE multiple difficult are:
- Geographic trends or market risk
- Company size
- The tangible and intangible business assets
- Independence from the owner or owner risk
- And many other variables.
The biggest factors influencing the SDE multiple are usually owner risk and industry outlook. If the business is highly dependent on an owner, it cannot be easily transferred to new ownership. This will potentially cause the business valuation to suffer. If you are selling a business in an industry or area that is expected to grow in the near future, the SDE multiple will be higher
- Add Business Assets & Subtract Business Liabilities
The final step of how to value a business is to account for business assets and liabilities that are not already included in the SDE. Most small business sales take the legal structure of an asset sale, which means the purchaser is buying the tangible and intangible things that make the business what it is. Typically the seller retains liabilities, but deal terms will vary from sale to sale.
Tangible assets are physical goods owned by the business that you can put a value on. Some examples include real estate, accounts receivable, and cash on hand. These are generally not included in the SDE multiple. All tangible assets should be added into the valuation separately if they are included in the business purchase.
Intangible assets are non-physical goods that have a value for a specific business purpose, like reputation, trademarks, patents, and goodwill. These assets are included in the SDE multiple because they are typically only sold upon the sale of the business assets.
The current liabilities of a business are debts or other obligations the business must pay in the future. When determining the value of a business, it is important to factor whether the business’ liabilities will transfer with the sale or be settled by the selling owner.
An asset sale is typically structured so that the seller pays off the business liabilities with proceeds from the sale. However, it gets more complicated when discussing things like an open line of credit or a facility that the business needs in order to continue operations.
Final Business Valuation Formula
Now with the above calculations, you can distribute all of your balance sheet lines into the appropriate category and use the formula below to come to an estimated business value:Business Estimated Value = (SDE) * (Industry Multiple) + (Real Estate) + (Accounts Receivable) + (Cash on Hand) + (Other Assets Not in SDE or Multiplier) – (Business Liabilities).
For most readers, inclusive of the author of this article, determining the 2022 worth of a business is a calculation and opinion that is best provided by experienced business brokerage services such as Bottom Line Management, found online at https://www.bottomlinemanagement.com and phone at 470-990-0160. For over 30 years, the Bottom Line financial experts have successfully assisted business buyers to obtain an accurate opinion of value of their business to get an idea of what their business is worth for future business dealings or the sale of the business.
Whatever the reason you need to know the worth of your business in 2022, contact Bottom Line Management for an Opinion of Value of your business that is accurate and reliable! https://www.bottomlinemanagement.com and 470-990-0160