Valuing a small business can be a daunting task, especially without professional help. But at Unbroker, we believe that business owners should have the tools to understand their company’s worth.
This guide will walk you through how to value a small business using proven methods and readily available financial information. By following our step-by-step approach, you’ll gain valuable insights into your business’s true value without the need for costly appraisers.
What Are the Main Business Valuation Methods?
Valuing a small business doesn’t require a one-size-fits-all approach. Different methods yield different results, and the best choice often depends on your business type and industry. Let’s explore four main valuation methods you can use without hiring an appraiser.
The Asset-Based Approach
This method focuses on the tangible assets of your business. It’s straightforward but often underestimates a company’s true value. To use this approach:
- Calculate your total assets
- Subtract your total liabilities
- The result is the book value of your business
While simple, this method doesn’t account for intangible assets like brand reputation or customer relationships.
The Market Approach
The market approach compares your business to similar ones that have recently sold (think of it as comparing house prices in your neighborhood). To use this method:
- Research recent sales of businesses in your industry and location
- Look for businesses with similar revenue, profits, and assets
- Calculate ratios like price-to-earnings or price-to-revenue
- Apply these ratios to your business to estimate its value
Websites like BizBuySell can provide valuable data for this approach. According to their recent report, a total of 2,368 businesses changed hands, representing an enterprise value of $2 billion-a 9% increase compared to Q1 2024.
The Income Approach
This method values your business based on its ability to generate future income. It’s more complex but often more accurate for profitable businesses. The most common income approach is the Discounted Cash Flow (DCF) method. DCF is a valuation method that estimates the value of an investment using its expected future cash flows.
The Rule of Thumb Method
This quick estimation uses industry-specific multipliers based on revenue or earnings. The Rule of Thumb Method helps understand how to apply industry multiples to assess your business’s economic value. While not as accurate as other methods, it can provide a quick ballpark figure.
The key to successful valuation lies in understanding each method’s strengths and weaknesses. Try using multiple methods and comparing the results. This approach will give you a range of values and a more comprehensive understanding of your business’s worth.
Your business’s unique qualities might not fit neatly into any single method. Consider factors like growth potential, market position, and competitive advantages when interpreting the results of these valuation methods.
Now that we’ve covered the main valuation methods, let’s move on to gathering the essential financial information you’ll need to put these methods into practice.
Essential Financial Documents for Business Valuation
Accurate financial information forms the foundation of any business valuation. Here’s what you need to collect:
Profit and Loss Statements
P&L statements reveal your revenue, expenses, and profit over time. Try to gather at least three years of profit and loss statements to illustrate your business’s financial trends.
Analyze patterns in your revenue and expenses. Do sales increase year over year? Have you reduced costs? These insights will prove valuable when you apply valuation methods. Financial statement analysis is used by internal and external stakeholders to evaluate business performance and value.
Balance Sheets
Balance sheets offer a snapshot of your assets, liabilities, and equity at specific points in time. They’re indispensable for the asset-based approach to valuation.
Focus on your current ratio (current assets divided by current liabilities). A current ratio above 1 indicates good short-term liquidity, which can positively impact your valuation.
Cash Flow Statements
Cash flow statements track the movement of money in and out of your business. They play a key role in the income approach to valuation.
Pay attention to your operating cash flow. A consistently positive operating cash flow signals a healthy business. A study found that 82% of small businesses fail due to poor cash flow management skills or poor understanding of cash flow.
Tax Returns
Business tax returns provide a wealth of verified information about your income and expenses. They often prove more reliable than internal financial statements.
Collect at least three years of tax returns. This allows you to calculate your average annual income, a figure often used in valuation formulas.
The quality of your financial information directly affects the accuracy of your valuation. If your records lack organization or completeness, take the time to put them in order. Consider using accounting software (like QuickBooks or Xero) to streamline this process.
With these financial documents in hand, you’re ready to move on to the next step: applying DIY business valuation methods. Let’s explore how to use this financial information to determine your business’s value without hiring an appraiser.
How to Value Your Business Step by Step
Calculate Seller’s Discretionary Earnings (SDE)
Start with the calculation of your Seller’s Discretionary Earnings (SDE). This figure represents the total financial benefit an owner receives from their business. To calculate SDE:
- Determine Pre-Tax Income (EBT)
- Normalize Owner’s Salary (Including Payroll Taxes)
- Add back any one-time or non-recurring expenses
- Add back any non-essential expenses that a new owner might not incur
For example, if your pre-tax earnings are $200,000, you pay yourself a salary of $80,000, and you have $20,000 in non-essential expenses, your SDE would be $300,000.
Apply Industry Multipliers
Research industry multipliers next. These multipliers vary widely depending on your sector. Business owners and buyers rely on industry-specific revenue and cash flow multiples to gauge what a business is worth relative to recent sales prices.
Let’s say you run a small retail business with an SDE of $300,000. If the average multiple for retail businesses in your area is 2.5, your estimated business value would be $750,000 ($300,000 x 2.5).
Factor in Unique Business Characteristics
Adjust this figure based on your business’s unique factors. Consider elements like:
- Growth rate: If your business grows faster than industry average, increase your multiple.
- Customer concentration: If a large portion of revenue comes from a few customers, decrease your multiple.
- Location: Prime locations can increase value, while less desirable ones might decrease it.
- Competitive advantage: Strong brand recognition or proprietary technology can boost your multiple.
For instance, if your retail business has shown consistent growth of 15% year-over-year (above industry average), you might increase your multiple from 2.5 to 2.7, bringing your estimated value to $810,000.
Account for Intangible Assets
Consider intangible assets. These can significantly impact your business’s value but are often overlooked. Key intangibles include:
- Brand reputation
- Customer relationships
- Intellectual property (patents, trademarks)
- Employee expertise
While it’s challenging to assign exact values to these assets, they can justify pushing your valuation higher. For example, if your retail business has a strong, recognizable brand and loyal customer base, you might add another 10% to your valuation, bringing it to $891,000.
This DIY method provides a rough estimate. For major financial decisions, it’s always wise to consult with financial professionals. However, this approach gives you a solid starting point for understanding your business’s value and can inform your growth strategies or exit planning.
If you’re considering selling your business, platforms like Unbroker offer cost-effective alternatives to traditional brokers. They provide tools and support for DIY sellers while eliminating high brokerage fees, allowing you to maximize the value of your business sale.
Final Thoughts
Small business valuation without an appraiser challenges owners but offers valuable insights. Multiple valuation methods provide a comprehensive understanding of a company’s worth. Accurate financial information forms the foundation for precise valuations and highlights areas for improvement.
Self-valuation empowers business owners to make informed decisions about their company’s future. It allows them to track progress, set realistic goals, and identify areas that need attention. Professional appraisers can offer additional expertise for major financial decisions.
Platforms like Unbroker provide cost-effective alternatives to traditional brokers for those considering how to value a small business for sale. Unbroker offers tools and support for DIY sellers, potentially maximizing the value of their sale. Understanding your company’s value equips you with knowledge that can drive strategic decisions and contribute to long-term success.
