- Sales Basis: Using sales as a basis for the valuation of a business is usually best for service related businesses with a fixed percentage of profit versus overhead and little retained earnings. These may include consulting firms, insurance brokers, temporary agencies, PR firms, professional practices and the like. Each business will use its own multiplier of the annual sales figure to arrive at a selling price, which is based on the type of business and other variables. The multiplier is often adjusted to account for changes in demand, competition, the amount of risk the business assumes, and general trends in the industry.
- Cash flow or profit basis: In this model, the sale price of a business is determined by its ability to generate a steady stream of cash flow or profit. By projecting this revenue stream over a period of five years or more, a business valuator can calculate the net worth of the business. Because profits are projected over a period of time, interest rates also play a role, meaning the money earned in year four will be less valuable than money earned in year one. This calculation is known as a “net present value” technique.
A professional business valuator or consultant may be able to recommend ways to more accurately calculate a fair selling price. Because they know about the factors that affect the multiplier and can quickly assess the current state of a business, professionals are usually more adept at coming up with the right price.
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