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There is a lot of conflicting advice about how to value businesses out there. You don’t have to pay thousands of dollars for a valuation unless you have to have evidence to support a valuation for the IRS or a court.

We always recommend that every business owner should know two numbers off the top of their head:

1) If I had to pay taxes today, how much would I need to write the checks for?

2) How much is your business worth?

You always want to be prepared if someone stops in and says, “hey, I’d like to buy your business. How much would you sell it for?” In reality that does not happen too often, but I have had people receive an offer and they had an unrealistic expectation in their head so they turned it down. In retrospect, these might have been some great opportunities to cash out.

Let’s take the emotion out of pricing your business first. We all understand that as a business owner, you put your blood, sweat and tears into this business so that has to be worth a lot, right? Yes, but the market value of that part is less than you think. Let’s look at some quick ways to determine what your business is worth.

First, let’s look to determine if your business is profitable. Is there any cash left for you as the business owner? If not, you really have a hobby and some equipment. Your business value is really the value of your inventory and equipment. If you find yourself in this situation, you probably need to get your business in shape to increase the value of the business before you sell it. This will take at least 3-5 years. It’s definitely not impossible, but you need to seek help from the experts like us.

If your business is currently profitable, your business is usually worth about 2-4 times the net cash flow available to the owner. How do we determine what that cash flow number is? You can use a simple valuation like this:

The owner preference items take into account that one owner could run a business differently than another. For example, one business owner could have a BMW budget and another could be on a Yugo budget (for those of you that don’t remember, that was a $3000 car). Adding back the preference items tries to take those things into account and bring the business back to a bare bones budget and remove the tax planning ideas that an owner could be utilizing to reduce taxes.

Once you have arrived at net owner cash flow, you must determine a multiple. The two, three or four multiplier is based on how crucial the owner is to the business. For example, in a CPA firm like ours, our names are on the building. If Bordeaux & Bordeaux, CPAs changes to Jones & Jones, CPAs, the business will probably lose some customers and there will be a “bump in the road.” If you are passive in your business and the business could go on without you without your customers noticing and no additional expenses would be needed if you are gone, then your business is worth more and a higher multiplier would be used. Think of the Subway shop near you. If that owner sold the business and a new owner was in place, their business would most likely continue just the same as it did the day before. The owner is easy to substitute. This business would most likely have a five times multiplier.

If you have plans to sell your business within the next 5 years, make sure you are getting your business ready to sell. Think about the owner preference items and determine if you might want to forego a tax deduction on some of these types of items to help you improve the “story” your business financials and tax returns tell.

We would be happy to help you look at your business values and show you how proactive advice can help you increase that value and lower your tax liability. Please give us a call to learn more about how we can help you grow your business’s value.