There are several components to consider when valuing a small business. The importance of each will vary depending on the business type, industry, and purpose of the appraisal, but the most frequently used are listed below:
Gross Revenue (Sales) and Net Income (Earnings)
These figures represent the heartbeat of the company and will play a significant part in the estimation of value for the company. Income statements will detail all the revenue and expenses of the business. The appraiser will look at both current and historical financial performance to fully analyze revenue and income.
Cash Flow and Debt Levels
Monthly levels of cash flow are crucial for understanding the company's ability to generate liquid cash to cover debts, reinvest, and support ongoing operations. Cash flow and debt level forecasts can also project future financial health.
Assets and Liabilities (The Balance Sheet)
Tangible Assets: Physical assets such as real estate, machinery, equipment, and inventory.
Intangible Assets: These may include intellectual property, trademarks, brand value, and goodwill.
Liabilities: All outstanding debts and financial obligations, including loans, taxes, and accounts payable.
Market and Industry Conditions
The overall economic environment and specific market or industry conditions and trends can influence the small business value. Typically, the better the market, the better the company will perform within it. Specific multiples of revenue and income will be analyzed and used in the overall calculation of value.
Customer Base and Competition
The number and diversity of customers can impact value. A large, diverse customer base reduces risk, while dependence on a few major customers can be risky. Steady clients and a strong brand reputation can add significant value to the business.
The strength and number of competitors in the industry can influence a business's value. A business with a strong competitive advantage (e.g., unique products, intellectual property, or location) is typically valued higher.
Growth Potential
Under the Income Approach to value, appraisers will assess the future growth potential of the business. Stronger growth potential will usually dictate higher value.
Owner Dependence
If a small business is highly dependent on the owner, its value may be lower than that of a more employee-leveraged company. Future buyers may be cautious depending on how long the owner plans to stay on and facilitate a transfer. Businesses that operate independently of the owner often command higher values.
In summary, these are some of the major variables appraisers review and analyze when estimating the value of a small business. Considering all these together provides a well-rounded view of a business's worth and helps determine its fair market value for potential buyers, investors, or during strategic decision-making periods.