Determining Business Value

A realistic business valuation requires more then merely looking at last year's financial statement; it requires a thorough analysis of several years of the business operation and an opinion about the future outlook of the industry, the economy, and how the subject company will compete.

Most people believe that a business should be sold for Fair Market Value. The term Fair Market Value is defined by the IRS at Rev. Ruling 59-60 as follows:

"the price at which the property would change hands between a willing buyer and willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts."

There are a number of different methods to determine a fair and equitable price for the sale of the business. The following lists a few methods to determine the price:

• Capitalized Earning Approach — This method refers to the return on the investment that is expected by an investor.
• Excess Earning Method — This method is similar to the capitalized earning method, except that it splits off return on assets from other earnings.
• Cash Flow Method — This method is usually used when attempting to determine how much of a loan the cash flow of the business will support. The adjusted cash flow is used as a benchmark to measure the firm's ability to service debt.
• Tangible Assets ( Balance Sheet) Method — This method values the business by the tangible assets.
• Value of Specific Intangible Assets Method — This method is based upon the buyer's buying a wanted intangible asset versus creating it. This method also takes into consideration valuing the goodwill of the business.