Would you buy a small business that is losing money and makes no profit at the end of the year? Without a professional business appraisal, you could not come up with a solid reason to either answer in the affirmative or entirely rule out such a purchase. If you have not done a company valuation and don't know what the struggling company is worth, the most intelligent way to answer the posed question is with a resounding maybe. How to value a small business that is losing money requires you to find answers to a number of different questions.
Why is the Company Losing Money?
Sometimes it is easy to identify the reason why a small business is losing money and sometimes the reason is not so obvious. The loss of sales or lack of profits might be due to temporary or unusual circumstances.
- An act of nature disrupts business for an extended period of time
- A cyber attack corrupts data necessary for the operation of the business
- A 6-month road construction project diverts customers from your store
As long as a small business has sufficient access to capital to make it through such temporary setbacks, they can usually recover. It would be wrong to reject buying a small business because it lost money due to correctable issues that were beyond its control.
Small businesses lose money all of the time due to poor planning, poor decision-making and bad management. Appraisals done under such circumstances are likely to produce lower business valuations than what might be if the negative issues were addressed and corrected.
- Poor planning can lead to inventory issues (too much or too little) that can hurt the bottom line
- Poor decision making (pricing, products, contracts etc.) may cause a business to struggle
- Bad management that does not utilize its assets wisely leads to lost opportunities
A new owner who can address these issues and unlock the company's true value, may create a substantially higher business valuation and earn a significant return on his or her investment.
What are the Company's Assets and Liabilities?
The valuation of a company always requires a close examination of the companies assets and liabilities. Before you buy a small business, you want to know what it owns and what it owes. Business appraisals do more than just list a company's assets and liabilities. They delve deeper and assess a company's worth by verifying the stated amounts on the balance sheet and books of the company. Looking at a construction company? Don't rely on book values of the machinery and invest in a construction equipment appraisal to understand the actual value.
Can the Company Start Making Money?
A business appraisal can help you assess whether or not the company you are considering can be turned around into a money-making proposition. In some cases, struggling small businesses are destined to fail because they no longer sell a product or provide a service the public wants. You would be hard pressed to create a scenario where a company that sold and installed pay phones could survive in this age when everyone carries a smartphone.
Temporary circumstances that cause a business to struggle can be overcome. A better marketing plan, new product line, or increased productivity, are just a few of the ways a struggling business can start making money again.
How Hard Will it be to Turn the Struggling Business Around?
How to value a small business may depend on how much time and money it will take to turn losses into profits. Obviously, the more time and money it would take you to "fix" the business, the lower the price you would be willing to pay for that business.
Buying a Struggling Business
Struggling small businesses often sell at a large discount to their potential value. Owners get tired and frustrated with what may seem to them as a never-ending struggle. They just want to get out and that creates a big opportunity for individuals looking to buy a small business. If you know how to value a small business, you can choose one that can provide superior returns and appreciate in value.