Common methods to determine the value of a business

We have found that the businesses we have taken through a formal business valuation process sell closer to asking price than those without valuations. Through the valuation process both sellers and buyers become better informed – making the entire process easier – from start to finish.

Asset Valuation

Asset valuation is used when a company is asset-intensive. Retail businesses and manufacturing companies fall into this category. This process takes into account the following figures, the sum of which determines the market value:

Fair market value of fixed assets and equipment (FMV/FA) – This is the price you would pay on the open market to purchase the assets or equipment.

Leasehold improvements (LI) – These are the changes to the physical plant that would be considered part of the property if you were to sell it or not renew a lease.

Owner benefit (OB) – This is the seller’s discretionary cash for one year; you can get this from the adjusted income statement.

Inventory (I) – Wholesale value of inventory, including raw materials, work-in-progress, and finished goods or products.

What does Asset Valuation mean?

Asset Valuation is the process of determining the current worth of a portfolio, company, investment, or balance sheet item.

How can I prepare for an asset valuation consultation?

Business appraisers, business valuators, and brokers start off requesting a copy of the past three years of tax returns and financial statements in order to prepare an overall view of your company’s asset valuation. Other key pieces of information include all the salaries and “perks” that are directly paid to the client and his/her family members. From there, we will examine other relevant analyses in order to conduct a detailed asset valuation.  Initial consultations allow us to get an understanding of your goals and make you feel confident that we can help you obtain these goals.

How are assets and earnings best demonstrated?

Most valuations require readjustments to tax returns and financial statements in order to appeal to the buyer. This is not to say we convey a false image of your company. It simply means we examine personal versus operating expenses, for example, and exclude personal expenses from the balance sheet and retain only those that are relevant to a potential buyer.

What if I have an SBA Loan?

Small Business loans are common amongst small to medium sized businesses. Note that if you have a small business loan exceeding $250,000 then you are required to have an accredited business appraisal expert perform a business valuation in order to establish the value of your business with the existing loan.  Furthermore, if you are looking to take out a loan, you must have a business/asset valuation in place in order to be approved for that loan.

Capitalization of Income Valuation


Capitalization of income valuation method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses such as service companies. “Cap Rates” can be derived from various methodologies. One such valuation method is the build-up method where statistical data are used from publicly traded companies. Other cap rates are derived from Industry Rules of Thumb and market sales.

Capitalization of Income Factors

In his book “The Complete Guide to Buying a Business” (Amazon, 1994), Richard Snowden cites a dozen factors that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the “capitalization rate” which is multiplied by the Seller’s discretionary cash to determine the market value of the business.

The factors are:

  • Owner’s reason for selling
  • Length of time the company has been in business
  • Length of time current owner has owned the business
  • Degree of risk
  • Profitability
  • Location
  • Growth history
  • Competition
  • Entry barriers
  • Future potential for the industry
  • Customer base
  • Technology

Owner Benefit Valuation


This formula focuses on the seller’s discretionary cash flow, and is used most often for business valuation in which value comes from their ability to generate cash flow and profit. Owner benefit valuation uses a fairly simple formula: multiply the owner benefit times a multiple consistent with the industry to get the market value. George and Company will carefully examine the Seller’s income statement to identify non-recurring and discretionary expenses.

If the expenses are non-requisite to the operation of the company, then they are added to cash flow. Certain non-cash expenses like depreciation and amortization may also be added to cash flow. The total of the owner benefit is usually multiplied by an industry specific number to arrive at market value.

Market Valuation

Commonly used by real estate professionals, the market approach determines the value of a business by using an “industry average” multiplier. This industry average is based on the price at which comparable businesses have sold for. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. These formulas, often called Rules of Thumb, can be troublesome because they may not focus on the bottom line; profits, earnings, EBIT or EBITDA. If an industry Rule of Thumb says company XYZ is selling for 50% of its annual gross sales, would you pay  50% for  those sales if the company was not profitable? In most cases, business people want to invest in something that is profitable, sustainable and stable enough to produce growth in the future. The market approach is key to opening the door to opportunities which allow you to make the best business choices.

The appraiser therefore tries to focus on industry formulae where they are applied to a multiple of earnings. This market approach is similar to analyzing a publicly traded company by its P/E (price to earnings) ratio. The approach, if enough empirical data is available, can very often be the most reliable valuation methodology for many industries. George & Company, because of their status as an appraisal and brokerage/intermediary firm, has an extensive data base of actual sales to draw upon. In addition, by means of membership, we also have access to many of the world’s largest data bases of done deals.

Here are a few Industry Multiplier examples:

  • Retail (Family)  1/3 of annual sales
  • Service Companies (General) 1.7 X annual net profit + inventory + equipment
  • Manufacturing (Job Shop)  3-5 times EBITDA plus WIP – with patent, 4-6 times EBITDA