Comparing a service-producing business to a good-producing business is like comparing apples to oranges. Apples and oranges can both taste delicious, but they have distinctively different flavors. A service-producing business and a good-producing business both sell something of value, but generate sales in entirely different ways. Although there are some common elements in the way a business appraisal is done for both sectors of our economy, how to value a service business requires a different approach than how to value a good-producing business.
Manufacturers are in the good-producing business and they typically make large capital expenditures to purchase machinery and equipment that is needed to produce the goods they sell. Service-providing businesses employ a large majority of the workforce. Some of the subgroups in the broad service-providing category include, financial services, retailers, and health care.
Since a service business does not produce any goods and usually does not have expensive machinery or equipment, a business valuation has to look at the ways that the service business generates revenue. How to value a service business focuses on some of the following variables.
Type of Service You Provide
The valuation of a company that provides a service can be affected by the level of demand for that service. For instance, as the population ages and Baby Boomers start to retire, the demand for health care services is increasing. If you run a company that provides home health care services that help people stay in their homes, your company valuation would benefit from the need for your service.
Seasonality
If you run a seasonal business where most of your revenue is generated over a period of several months, your service business carries a higher risk than another service business that derives its revenues in a more steady pattern spread out over the entire year. A disruption in service of a seasonal business can have a bigger impact on the company's bottom line and thus lower its inherent value. Company valuation is based in part on the expected stream of future revenues.
Brand
Having a strong brand can increase the value of a service business. A small business owner may operate a national franchise like Dunkin Donuts or Subway, and be worth more than a non-branded coffee or sandwich shop.
Client Base
Business appraisals tend to be higher for companies that have a large and loyal client base because it indicates that there will be a steady flow of business. Whether you have long-term contracts with other businesses, or have developed a following over the years, just about every service company needs repeat business to survive and thrive.
Time in Business
An established service company is usually considered to be more valuable than a competitor who has only been in business for a short time. It takes time to build a good reputation and get customers to switch their loyalties from an established company to a new company. A business appraisal of a service company should take into account the number of years the company has been in operation.
Growing or Mature
All other things being equal, a service company that is growing will always have a higher valuation than a service company that is mature. A mature company may have steady business, but revenue will remain fairly constant over time. A company with good growth will build its revenues over the years and thus, is more attractive to a buyer, and also given a higher business valuation.
Competitive Advantages
A service company that has a competitive advantage may be able to lower its costs of providing the service or offer its service for less than its competitors. Competitive advantages can be anything from a better physical location, better access to information, or having the most qualified and experienced staff of experts in town.
Appraising your Service Business
How to value a service business depends on looking at the hard numbers and also considering some of the less tangible factors that add value to a business. If you want an accurate estimate of the value of your service business, you should consider hiring a certified business valuation specialist.