The most appropriate valuation method applied by qualified Business Brokers for valuing a small business (defined as a business with annual sales of $5 million or less) - is an Income Based Valuation.

An Income Based Valuation approach can be broken down into four generally accepted methods as follows:

1. Present Value of Future Earnings
2. Gross Revenue Multiples
3. Capitalization of Excess Earnings
4. Multiple of Discretionary Earnings

The valuation method applied by most qualified business brokers or business appraisers for businesses for sale will likely be a combination of both the widely used and professionally accepted Capitalization of Excess Earnings method and the Multiple of Discretionary Earnings method. This is a powerful way of estimating the value of a business and allows for the business to be fairly valued as an investment opportunity without many of the uncertainties that other valuation methods introduce. This method assumes that a business owner is entitled to a fair return on the value of the business (his/her investment) over and above his/her fair wage (if the owner(s) works in the business). This combined approach will assign a financial value to the company’s reconstructed earnings (resulting in available discretionary earnings) that are reflective of the risk associated with the continued operation of the business in light of recent proven financial results that can reasonably be expected to continue after the business purchase for an indefinite but substantial duration.

Using the two valuation methods described above also enables one to calculate the goodwill value in the business as well as its estimated fair market valuation. Furthermore, this approach works equally well whether the business to be purchased is operating as a sole proprietorship, partnership or as a corporation. Thus, these valuation methods are based on the income a business has proven it can earn with the expectation being that the recent level of actual earnings of the business will continue at or above that level for some reasonable period of time. The estimated fair market value of the business based on its proven earnings will be strongly affected by applying a factor (a return on investment multiplier/capitalization rate) taking into account the projected risk and certain investment considerations associated with new ownership.

It is always beneficial to obtain and Income Based Valuation method as an accurate reflection of the List Price and is often relied upon by most buyers to justify their acquisition.

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This entry was posted on Sunday, February 10th, 2008 at 10:10 pm and is filed under Quantum Advice. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.