Placing a value on a business can be a tricky proposition that is based on many different assumptions and assertions. Service businesses, in particular, can be hard to stick a price tag on because their value is dependent on more ethereal assets, such as future revenues.
In your financial advisory practice, you may not have considered how much your business is worth, especially if you are still working hard on growing its value. Understanding how much it is worth, however, can not only help with your financial plan, but can also help to make decisions about whether or not to sell the practice.
Ultimately, the value of a business is what someone else is willing to pay for it. You can define a range for the value of your company, however, that gives you an idea of what it would be worth to someone else.
A "floor" is the lowest price that someone would pay for your business. The floor is often defined as liquidation value of the assets of your business, meaning what it would be worth if you had to wind it up right this minute.
All of the hard assets in the business, such as computers, office equipment and supplies would be sold off for what the individual assets are worth. The cash received from these assets would have to be used to pay off any debt the company has, such as credit cards, loans and lease buyouts. Whatever is left over is the liquidation value of the company and provides your bottom, or floor, value.
The Ceiling: Times Revenue Method
For a financial services business, the floor is likely to be small, as it is not a capital-intensive industry. The main value of the business lies in its client base. Placing a value on your clients is often problematic, because there is no guarantee that they will continue to be clients of the practice after you sell it.
A common valuation method used by professional business valuators to come up with the maximum value of a company, or its ceiling, is to use a multiple of current revenues; this is called the times revenue method. Revenue is more often used as the benchmark than net profit because expenses can differ greatly under different management. The multiple is based on conventions in the industry and on local conditions. One to two times revenue is a common valuation, with higher valuations being more likely for fast-growing businesses. For example, if your total revenues in the past full fiscal year were $92,000, a buyer may be willing to pay $92,000 to $184,000.
The Ceiling: Earnings Multiple Method
In the case of a stable, mature practice, sometimes the earnings multiple method is used. This method begins with the earnings of the business before interest and taxes (EBIT), minus other unusual expenses. For example, if the company's EBIT for the year was $47,500 and it contained $3,500 in uninsured losses and $1,250 in lease buyout costs, those items would be removed and the normalized earnings would be $42,750. The valuation would be based on a multiple of this net profit, which is often around three or four. In the above example, it would mean that a buyer might be willing to pay between $128,250 and $171,000.
Once you have both the floor and ceiling values estimated, you know that your business is likely worth somewhere in between. Researching recent sales in your area of similar businesses will give you a better idea of where the value of your business falls.
The Bottom Line
Estimating the value of your business allows you to include it in your personal assets and enables you to better plan for the future, whether or not you plan on selling it in the near term. Business valuation is not an exact science, but an art. Ultimately, your business is valued at what someone would buy it for.