Posted: 2010-03-01 / Author: Bob Power
Valuation Does Not Equal Price - “what Is A Business Really Worth”
It must be stressed that there are no standard methods for valuing a business, there are various possibilities used, but are really no more than a guidance factor.
The main reason for seeking a valuation of a business is so that a purchase price can be ascertained. However, have no doubt that the price eventually paid could be very different from the valuation calculation. In all my experience I have rarely concluded a deal on the valuation given by an auditor or other adviser, whether buying or selling. The seller wants as much as possible, whilst the buyer wants to pay as little as possible.
The reasons for these statements generally centre around the following factors-
Never buy a business because the price is right, be certain that the business itself is right for you.
It must be repeated that there is no single, correct answer to the question of how much a business is worth. There are however, certain criteria common to all business enterprises which enable basic valuation rules to be formulated and applied to businesses in general. Also of importance is the way a business is valued will depend on the category of the business enterprise. There are a lot of differences between a service business and a manufacturing business.
Although a variety of procedures may be used to establish reasonable value, the basic principle is that the value of the business assets is determined by its expected or potential earning power and the degree of risk or uncertainty involved. Ultimately the value of a small business will depend on its profitability, and the ability and capacity to expand that profitability.
Investors and other interested parties are attracted to enterprises which have a stable cash flow history and show good prospects in respect of future earnings.
It must therefore be noted that the real value of a going concern business lies in its future earnings rather than past earnings.
At a seminar I attended a few years ago, 15 of us were given the exact information (financials) etc on a mock business, and asked to value it, and we came up with 15 different valuations.
A mentor of mine many years ago, ( I believe that what he said is true today) advised me “There is no correct method for valuing a business-, due diligence, negotiation experience, judgment, ‘business nose’ and horse-trading skills all have an important impact on the final outcome”.
At the end of the day a business is worth what a buyer is prepared to pay and a seller prepared to accept.
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