The process of valuing a business has sometimes been referred to as more of an art than a science. Here is a fundamental truth about the valuation of an enterprise. It is only worth what someone is willing to pay for it. You might say that this is not a very helpful statement. If you want to know the value of your business, how can you know how much it is worth before someone pays for it? You can't (exactly). But you can have a person (usually an accountant or a broker) give you a value. But what this really entails is an estimate of what the person doing the valuation thinks a willing, but not anxious buyer, who is fully informed might pay. But it is only ever going to be an estimate. The true value cannot be known until someone puts their signature on a contract with the sale price on it.
In Australia, as probably in many other parts of the world, the population, on average, is ageing. There is an enormous shift of wealth and assets from the older to the younger generations. And this means there are a lot of business sales occurring and going to occur. Now when you sell something, you have to have an idea of what you're going to sell the item for. In a business sale, the price is not often openly disclosed. The purchaser needs to make a bid for the business. Therefore the purchaser also need to get a value of the enterprise, or at least some idea of a reasonable price.
All this is to say that determining the fair value of a business is now, and is going to continue to be, an important issue. It is somewhat disconcerting to say that the value of the business is more an art than a science. Surely the value can be determined/estimated fairly accurately? Well, often not. This is because there are so many different issues that valuers take into account. Some valuers will put more emphasis on a particular issue as compared to another. One valuer will have more knowledge of an industry than another and see value in certain things that another will not and so on.
Rules of Thumb
It seems that the smaller business, the easier it is to determine/estimate its value accurately. This is particularly so where there are large numbers of essentially the same types of business. An example (in Australia) is Fish and Chips shops or small accounting practices. Readers from other countries might relate more to a take-out pizza shop.
The reason for this is that "rules of thumb" have developed in relation to these types of organisations. Often these rules of thumb are based on the turnover for the last financial year. For example, an enterprise in a particular industry might sell for two times revenue. That is, if the annual sales were $500,000, it will sell for $1 million.
On its face, this seems illogical. How can you purchase a business based on sales without knowing the profit? The reason that rules of thumb gain wide-spread use is because the rate of profitability of businesses of the same type are assumed to be about the same, or if the business being purchased has lower than the standard rate of industry profitability, it is assumed that the new owner can quickly achieve that rate of profitability due to the business being so generic.
However, be careful using rules of thumb. Sometimes they can produce absurd valuations.
Wishing you easier business.
John Jeffreys
John Jeffreys wants you, the business owner or manager, to have an easier life. John Jeffreys helps you to achieve this by drawing on his 30 years business experience as a Chartered Accountant and partner in major accounting firms. For instant access to videos, audios and software products, visit http://www.businessease.com.au
Article Source: [http://EzineArticles.com/?Business-Valuation-Methods---Why-Rules-of-Thumb-Work-For-Many-Small-Business-Valuations&id=2604772] Business Valuation Methods - Why Rules of Thumb Work For Many Small Business Valuations
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