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Several factors determine the worth of a business 21 May 2012

How much is your business worth?

The short answer is what someone will pay for it. There are several things to consider when buying or selling a business. The first step when valuing a business is to find other sales within the same industry. The price others have paid is a good guide. Often, however, there is very limited opportunity to do this. The more unique a business is, the more unrealistic it is to compare it with others.

Several factors affect the price of a business.

Here are a few:

  • A business anyone could operate will attract more buyers than one requiring specialist knowledge. The price is therefore higher because demand for the business is greater.
  • More people can find $100,000 than $1 million. The smaller business would therefore be proportionately more expensive than the bigger one.
  • Economic conditions can have a big impact. People with redundancy money eager to buy a job in the form of a small business are more abundant when there is a recession.
  • A business with growth potential is worth more than one nearing the end of its life cycle. Who’d want to buy NZ Post in its current form these days?
  • Someone buying a business which has unhappy staff might be buying problems. • Dependence on a few customers or suppliers could be disastrous.
  • Some businesses, such as supermarkets and pharmacies, have an industry rule of thumb for calculating a price, which can be a good guide.

Adjusting the profit

  • One way to view a business is to see it as a machine which makes money. Start with the profit plus wages paid to the owners. How much is this?
  • Deduct the wages you would have to pay someone else to do the job done by the owners. This might be more than the owners are paying themselves.
  • Adjust for any expenses you see as artificial. A charge for the use of your home might be one of these. This is a cost the owner would incur even if they had no business.
  • Adjust for abnormal expenses or income, such as a major one-off advertising campaign.
  • Adjust for income which would not go to the new owner, such as interest on investments.
  • Adjust the profit for any extra interest you would incur if you borrowed to buy the business. When you have arrived at your adjusted profit, it’s time to get advice. Our ideas above will get you started, but don’t rely on them completely, as they are not comprehensive or determinative. There is much more to valuing a business. For example, the figures supplied to a buyer might be suspect. Instead, use this article only as a first step for thinking about what a business might be worth.

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