We live in an interesting time, which is not just a Chinese curse.   Baby boomers (born between 1946 and 1964) are now looking to sell and retire, and so the number of businesses on the market will increase significantly in the next five to ten years.   There will likely not be sufficient buyers for these businesses, and so the oversupply will lower prices.   Those relying on the proceeds to fund their retirement will therefore need a plan to ensure they obtain the highest price.   That's obvious, but easier said than done.

Hence the question:   When is it time to worry about the value?   The answer is always!   To achieve a higher price requires changes, and you may need 2 to 3 years to make all the changes necessary.   A good business should aim to improve profit, cash flow, and valuation, every year.   These are essential benchmarks anyway.

The valuation process is not all that complex.   Certainly the methodology is important, including the appropriate profit multiple, the value of hard assets (plant, vehicles, fixtures & fittings etc.,) and the future maintainable profit.   Expected future profit needs to consider factors such as the industry, economic conditions, the market, and special issues for this particular business.

However, don't get bogged down on complicated concepts, use a simple 5-step approach:

1) Work out the EBITDA for last year

2) Adjust for significant circumstances, like payment of a market salary to the owner, add backs like the cost of running a car used privately, an unusual cost such as a one-off bad debt, maximum owner superannuation, accelerated depreciation, etc.

3) Select a profit multiple that the business should sell for, perhaps 2 or 3, or even more if the business has a strong competitive advantage

4) Value is EBITDA x the multiple

5) Subtract any external debt.

The result in 4 is the value, and in 5 what the owners are likely to have left over.   Compare to book value, and if less than book value, the business is destroying value (insufficient profit for the level of debt).   Also compare to business broker web sites, and if the value is more than comparative businesses, it could be because you have significant differentiation (but it could simply be your multiple is too high).

Focus on the 7 Drivers of a business for improvement, which are:

                                Price                                         Volume                                          Direct Costs (purchase goods)

                                Overheads                             Debtors                                         Stock

                                                                                  Creditors

Often it is the focus on just one or two areas that result in the major benefits.

When you know where to focus, it makes the task so much easier.   We use a couple of pieces of software to model how small changes can make a big difference to the results.   We'd be happy to show you too – part of our Complimentary Client Review service.