What’s My Business Worth? Part 3: The Income Method
“What’s my business worth?”
This post is the final installment in a three-part series on valuing a business.
Buyers: Financial or Strategic?
For most businesses and in most situations, the Income Approach is the best method of valuing a business for the simple reason that it answers the buyer’s biggest question: “How much will this business put in my pocket?”
We’ve launched a coaching program specifically tailored to Realtors that want to sell businesses and to novice business brokers.
If you’d like to learn more, email me at joe@WorldwideBusinessBlog.com
Revenue or Earnings?
One of the calculations we use when valuing a business is the capitalization of earnings method which is used to value a business by estimating the net present value of its projected future earnings. It does this by applying a “discount rate”, approximating a buyer’s required rate of return given the risk the investment entails. But in order for this method to be at all meaningful, we have to start with the business’ actual earnings.
_____________________________________________________________________________
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches how to value and sell businesses.
Become a Professional Business Broker…
That business, even if we used the somewhat low cap rate of 25%, would be worth, at most, $60,000. But I would argue that, unless the business just signed a lucrative 10-year contract with one of the Federal government’s countless ridiculous, wasteful and nonsensical departments – such as the Department of Defense which recently spent $283,500 to monitor the day-to-day life of baby gnatchatchers – the risk to its survival is such that it would warrant a higher cap rate – say 35% – which would value it at less than $43,000. The Income Approach must be used with the Market Approach insofar as “the market” will tell us what similar businesses with similar earnings numbers have sold for but the Income Approach is the only one that answers every buyer’s question: “How much will this business put in my pocket?” And the only way to get an answer worth having is to start with the right numbers.The Bottom Line
The bottom line here is essentially exemplified in the adage that was coined in 1957, roughly the beginning of the computer revolution: “Garbage in, garbage out.” It is the concept that flawed or nonsense input data produces nonsense output or “garbage”. For us, this means that, in order to arrive at a meaningful result, we have to have all the correct numbers. If the advice in the article I read was followed by any business owner, that owner’s business would never sell. If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast. I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe

The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at joe@WorldwideBusinessBlog.com