Pricing a business is both a science and an art. The valuation of a potential buyer and that of a seller or even an independent third party are very unlikely to be the same. The reason for this is that there are no hard and fast rules that everyone adheres to when it comes to determining the price of a business (especially private businesses).
Profit is undeniably a great guide. Nevertheless there are many valuation guidelines applicable to different industries and sectors which can assist in giving additional “objective” valuations. In many ways it all comes down to predicting the amount of money a business will make, valuing its assets or using an appropriate earnings multiple.
Discounted Cash Flow: In short this is based on the future cash flows of the business and is used for more established businesses with a consistent track record of earnings and profitability.
Asset based approaches: If the business has a large tangible asset base (like plant and machinery used in manufacturing) then a valuation of its assets could be used.
Earnings Multiple: A valuation can be established by multiplying profits or free cash flow by the same earnings multiple which companies in the same sector have received. Keep in mind some sectors are a lot more highly rated than others.
Many other factors will influence valuations and it is important to apply the right valuation model most suitable for the type of business in question. Some businesses hardly have any assets, while others do not generate much cash.
The role played by intangibles should also not be underestimated. The importance of valuable trained employees who are prepared to remain with the business, brands, licenses, contracts, relationships built up with customers are all important assets that have all to be fully understood by potential buyers.
Valuation of a business is absolutely necessary before any sort of sale negotiation can begin and the whole process should be conducted early. Rather than doing this alone to get advice from experts is money well spent if it helps an owner realize the full value for the enterprise that they have built.
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