Its natural for a business owner to wonder: what is my business worth? What would someone pay you to cash out so you could spend the next six months at the beach?
There are many detailed and intricate methods for calculating business value. But, there are really two key elements buyers pay for: goodwill and cash flow.
Understanding both can help you estimate how much your business is worth and show you how to grow its value.
Goodwill is the name, reputation and relationship between the business and its customers. Goodwill boils down to providing customers what they want, when and how they want it, easily and at a reasonable price.
You enhance goodwill by focusing on customers and improving their experience and interaction with your business. You want to make the customer experience consistent with their highest expectations and more.
Many owners think this just means superior products and services. But being technically competent isn’t enough.
For example, if your accountant does a fantastic job preparing your tax return, finding the most deductions, but doesn’t return calls or files the return late, you won’t be satisfied. Doing the job well must go hand-in-hand with a bedside manner.
Customers understand problems can and will happen. If your business is organized so your team can take care of those problems, though, the customer will be satisfied (some say even more than customers who don’t have a problem). The difference is the relationship with the customer.
Goodwill is important to business value because it translates into a consistent, growing and profitable business that generates cash flow.
Cash flow is what is left over after all expenses (including owner’s salary) have been paid.
Like it or not, cash is king. Cash flow is business fuel that a buyer will use to evaluate and purchase your business.
Business value is tied to cash because there must be enough cash flow to pay a buyer’s salary and make purchase payments or provide an investment return. You can back into business value if you know how much the payments will be for the buyer’s loan to buy the business.
Say you were looking for a buyer to put down $100,000, your business generated $75,000 of annual cash flow and you’re willing to carry a note for 5 years at 8% interest. Your business would be worth about $380,000 with the annual payments on the note of $68,129. This would allow the buyer to pay your note from business cash flow.
Of course, you could vary the terms by extending the note or reducing the interest rate. The price would increase as well as your risk.
Another way to determine value is to examine return on investment. Generally, a buyer will expect between 17% and 33% annual return from a small business, depending on the time its been operating, the consistency of cash flow and other factors.
This means the estimated business value is 3 to 6 times cash flow. Assuming, again, $75,000 of cash flow, your business would be worth between $225,000 (inconsistent cash flow or young business) and $450,000 (rock solid cash flow). Most values are in-between.
Increasing your business value means building goodwill and growing cash flow. Doing both will put you in a position to cash out and sit on the beach for a few months.