The Asking Price

The first step in pricing or valuing your business is to “normalize” your financial statements or prepare them so that you can value your business. After you have done this, you can now begin the process of valuing your business.

How do I price my business? Pricing a business is primarily based on how profitable the business is. This is the number one thing that buyers are looking for and therefore the basis for how buyers value a business when making an offer.

There are other variables that buyers consider when buying a business; however, nearly 90% of them are looking for one thing – “profit” (or “adjusted net” or “discretionary earnings”). What would you look for if you were buying a business? Wouldn’t you look for a business that is making the highest profit or adjusted net possible?

But how do you define “profit”? “Profit” is really what you put in your pocket and should be the figure that you came up with when normalizing your financial statements in the previous step.

Other terms for “profit” include the following:

  1. Seller’s Discretionary Earnings or SDE – This is the most common and is used by nearly every broker and almost all buyers who have dealt with brokers.
  2. Seller’s Discretionary Cash Flow or SDCF – This has been replaced by SDE (above).
  3. Cash Flow.
  4. Adjusted Net Profit or Adjusted Net.

Method #1 for pricing your business – The Cash Flow Method

Step #1:

Figure out the cash flow (This is called “recasting” or “normalizing” the financial statements.) and this involves adding back to the profit the following items – depreciation, amortization, owner’s salary, non-cash expenses, non-recurring expenses, and other perks.

Step #2:

Multiply the cash flow by the “multiple”. Here are common current multiples:

  • Retail businesses: 1-2 times cash flow (restaurants, clothing stores, etc.)
  • Service businesses: 1.5-2.0 times cash flow
  • Manufacturing businesses: 3.0+ times cash flow
  • Wholesale businesses: 1.5 – 2.5 times cash flow

Example: $100,000 (Cash Flow) x 2.0 (the Multiple) = $200,000 (Business Value)

Please note that these are current multiples. They were actually much higher before the downturn. How do you determine the appropriate “multiple”? Unfortunately, this can only come from experiencel however, the guidelines above can be a useful starting point for you. If you need assistance, please call us and we can give you some guidance. This first method is the most widely used and it is used for nearly every business that is profitable. It is quite simple.

Method #2 for pricing your business – Comparable Sales

What about comparable sales? This is tough. They are not public record and are only privately disclosed. The best place to get this information is from a broker that has accesses to private databases. There are three to four databases with comparable business sales; however, the information is very sparse and often quite inaccurate. Call us and we can tell you what the multiples may be for your business.

What should the price include? It is simple. The price should include anything that is used or needed to create the “cash flow” or “profit”. This includes all of the equipment that is considered “required to operate the business,” and that is used in the daily operations.

What about inventory? This is a common debate among experts and you can safely try to get paid for the inventory in addition to the price. It is going to be negotiated anyway so ask for it upfront and see what happens. We could write a 50-page article on this but we won’t – we believe in keeping things simple.

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