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Whether you are buying or selling a small business, you need to know its worth. If you are a small business owner, before trying to sell the business, you need to get it appraised by a good financial team. Similarly, if you are planning to buy an existing small business, you need to get that business appraised as well. Otherwise you would end up paying more than its worth. Determining the value of a small business can be a challenging task, but it is worth the effort. We have put together a few points which will be helpful when you are buying or selling a small business.

  • Hire a business attorney – An experienced attorney would be able to appraise the business which you plan to buy or sell. He would know the right questions to ask and formulas to use to arrive at a fair value, which will not hurt both the parties.
  • Review the profits of the previous years – Whether you are a seller or buyer, you should review the revenue reports of the business. This is a great way to find out if the business was running on a loss or profit. Hire an experienced accountant to get the job done.
  • Check out the average selling price of similar business in your area – You should be aware of the selling price and revenues of similar small businesses. This will help you calculate the profit the business is likely to make.
  • Examine the revenue of the business – As a buyer you should analyze the growth of the business carefully before making your decision. If the revue does not show a steady growth to signify a positive standing, then you should think twice before buying the business. Otherwise, if you think you have a strong business strategic plan that will turn things around, go ahead and purchase the business but at a lower price.
  • Hire an experienced external appraiser – Whether you are a seller or buyer, it is always better to hire a reputed appraiser. Look for someone who has had experience in your area to give you a valuable opinion of the business and the true value of the business.

Commonly Used Business Valuation Methods

  • Asset Valuation- This method is used to calculate the value of all the assets of the business you are planning to buy or sell. Asset valuation is more appropriate for companies with large tangible assets. The value is calculated by calculating the net realizable value of all assets.
  • Entry Cost - The value of the business is calculated based on the cost to start a similar business to that being sold. Here you have to include the cost of not only hiring and training, but also the cost of developing a customer base, purchasing assets and developing the products/services.
  • Multiple Income – This procedure is followed by those businesses with an established financial history. The price divided by earnings (P/E ratio) represents the value of the business divided by its post tax profits. Since it is not easy to decide what P/E ratio to use, experienced and reputed business advisors usually suggest a valuation of between 5 and 10 times the annual post-tax profit. This method of valuation has many limitations while evaluating a small business.

The other factors that you need to take into consideration while evaluating a business is its intangible assets such as goodwill, brand, reputation, the key employees and the quality client/customer base.

When a business owner decides to sell his business, he is likely to quote a larger figure than the conventional industry price. He puts a charge for his years of hard work and time spent. Therefore, as a buyer you should always consult a reputed accountant or business advisor before buying an existing business.

Flickr image by Diana Parkhouse

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