There are many different approaches to business valuation when selling a business. Here is a simple explanation of some of the more common methods.
Profit Based Valuation
This method is used for small business where the owner is very active in the business and the buyer is effectively buying a job for themselves.
Value = Plant and Equipment + Annual Net Profit before deductions of Interest, tax, depreciation, and salary of the owner.
This method does not work for larger businesses.
Discounted Cash Flow Valuation
This method is used when there are medium term or longer predictable cashflows usually backed by contracts. An experienced professional adviser needs to be engaged to assist with determining value using this method.
Capitalisation of Future Maintainable Earnings
This is probably the most common methods used where the annual profit is multiplied by a number. Accountants often talk about the multiple when talking about this method. If the future maintable earnings is considered low risk and set to increase then the multiple would be higher than a high risk decreasing future earnings.
Value = EBIT x (Multiple)
The multiple is usually estimated using similar industry transactions to gauge value.
This methods values the business on the assets at a liquidation value and carries no goodwill. Typically distressed businesses or businesses facing insolvency might sell at these values.
Rule of Thumb
Where there are a lot of businesses in an industry that fairly regularly sell, there is a rule of thumb in valuing these businesses. Businesses like milk runs, news agencies, accountancy practices, legal practices.
Valuations are an excellent guide and there are professionals who can guide you on the value of your business. But remember it is only a guide and when the effects of supply and demand kick in, it could mean more or less than the valuation.