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Business Valuation Made Simple

Published : 4 January 2016 Author : Harry Notaras Comments :

While the reasons that someone wants to buy a business may be many and varied, the value they put on it will generally come down to the income or profit it generates. Here are a few rules of thumb to help guide you when trying to guestimate the value of a business.

 

Average Weekly Ordinary Time Earnings (AWOTE)

At the writing of this article the AWOTE in Australia was about $1476.30.  If someone can go and get a job and earn this amount of money without having to buy it, why would they pay for a business that produces this much or less?  The answer to that is unknown to me, but people do.  Not very much mind you.   It will generally fall within $15,000 and $45,000.

Proprietors Earnings before Interest Tax Depreciation and Amortization (PEBITDA)

When the income a business generates competes with what a buyer would be able to earn by simply getting a job then it is time to look at PEBITDA.  This method of valuing a business rests on the idea that what a buyer is actually purchasing is a job.  You have to calculate what one working owner earns in the business in one year.  Quite often this involves costing out a spouse or partner. No one is interested in what two people earn in the business when it comes to valuing it.  If two of you own it, make sure a wage is included in the costs for one of you. The value of the business is a number close to one (between say, 0.75 and 1.25) multiplied by the PEBITDA.  You may also get a few dollars for plant and equipment, but not many.

Earnings before Interest Tax Depreciation and Amortization (EBITDA)

This is a method of valuing your business like it is an investment.  In this method of valuation everyone, including the owner, is costed out of the business.  It may be necessary to estimate what you would pay the owner running the business as if they were a paid manager.  This is also known as the European Vacation scenario.  Pretend that the owner is on a permanent European Vacation and profits are simply sent to Europe to maintain the owner’s lifestyle. This amount of income is multiplied by a number between 2 and 4 to arrive at the valuation.  EBITDA should be at least about $200,000 in this scenario. Nothing is added to the value for plant and equipment.

 

Return on Investment (ROI)

A good check to see if a business is valued close to reality is to have a look at what the return is on the investment.  Simply divide your chosen calculation of earnings, which should probably be EBITDA, into the amount outlaid in the purchase of the business.  Valuations of businesses with lots of stock, work in progress or with a large requirement of working capital should be tested using this calculation.  If you get an offer for your business on the basis of a 25% return it is really worth considering taking the money and running in the current environment.  This number can go up to 50% or more which is lousy if you are the seller.

 

Return on Equity (ROE)

Not worth talking about at this stage in the cycle.  If you find a banker willing to lend money on business security you should check for a pulse.  They might be a zombie.

 

 

Harry Notaras

Harry Notaras ABS Business Sales

Business Broker - ABS Business Sales

Phone: 07 3368 4010

Mobile: 0434 344 282