Have you ever wondered how businesses are valued? There’s a lot of ways that businesses are valued, it can be
- a rule of thumb,
- multiplier on net profit
- future maintainable earnings.
There’s all kinds of calculations that that take place. Generally, what happens is sale of business figures are prepared, which means that we get your normal figures, we take out any costs that are directly related to the way that you run your business.
Generally this means expenes that are not cash expenses, so amortisation of black hole expenses come out, depreciation comes out, interest on loans comes out. Any motor vehicles that have partial private use, anything like that comes out, and generally the wages of the owner. That way, the person who is purchasing can make their own decision as to whether they’re going to work in the business or not, and put in what return they’re expecting to gain on the business.
Then dependent on your industry, then the actual net profit that’s left is multiplied by a multiplier. This multiplier can be as little as one times and as high as ten, or fifteen times. Now ten, or fifteen times is definitely not the norm. Between five and seven times is the norm for financial planning businesses. Most businesses at a times multiple between two and three times of net earnings.
How does this work? We get three years of financials, we add them together then divide by three to get an average, and then we multiply this average profit by the relevant multiplier to determine business value. This purchase price is the return on the goodwill of the business. Stock is generally a different addition to this and a stocktake will be performed by both parties at settlement. If the business has a lot of plant and equipment, this is generally valued separately.
So generally, financials are prepared and businesses are valued on a times multiple. Business brokers are the experts in this area. They know depending on industry, what your business will be worth. Accountants do often have a pretty good idea as well and if not, we can ring the local business broker and get an idea.
So if you’re thinking about getting your business for sale, just remember the less reliance that you have on you the more processes and procedures and the other people doing the work rather than yourself. The higher your multiple will be. Also, speak to your accountant well in advance so that you can prepare in advance to get the highest possible price for your business.