Selling a small business can be quite a difficult task. Whether you started it from scratch or bought it from some else, it’s important to assess the right price. But how to calculate the selling price of a small business?
How to Calculate the Selling Price of a Small Business 101
1. Check Your Financial Statements
If you used to keep all the business records in corners of your home, it’s time to put them all together. Get the financial records you have for this year, as well as for the previous three if your business was set up back then. However, things can get quite complicated, so if you don’t have any skills when it comes to accounting, you should ask for help from an accountant or a bookkeeper. These are the forms you will need:
- Discretionary earnings statement of the seller – also known as an owner’s cash flow, it shows how much your company makes after you back out the discretionary and non-recurring expenses;
- Balance sheet – the value of all the tangible assets your business has, minus the liabilities owed by it;
- Cash flow statement – how the business received and paid out the money; it also includes how the business assets were changed as a result;
- Income statement – presents the costs, the gross revenue, as well as the amount of money made or lost by the business each year.
2. Estimate the Tangible Assets
The next step in our guide on how to calculate selling price for small business is to make a list of all the physical assets of the business. Include the fixtures, furnishings, inventory, and equipment. Make sure you add a price to them as well. But why is this important? The business buyers will ask you to offer a full asset list that includes both the purchase prices, as well as the current market values for the items. At the same time, this is important to you as well. If you see that the value of the assets is like the price you’d get through a sale, you may want to decide on liquidation instead.
3. Get the Statement of Seller’s Discretionary Earnings
Work together with an accountant or bookkeeper to make up your statement of owner’s cash flow, also called the statement of seller’s discretionary earnings (SDE). Regardless of what you call it, it represents the base for sale pricing, as well as the primary interest for any buyer. This is different from the income statement.
While the income statement shows the entire list of normal and legal deductions, the SDE reflects the full earning power the business has. The result should be calculated after you add back in the non-recurring, one-time purchases, as well as the discretionary expenses present on the income statement.
4. Estimate the Earnings Multiple
When learning how to calculate the selling price of a small business, you should know that most small businesses manage to sell based on an earnings multiple of 1 – 4. This means that the owners get something between 1 and 4 times their annual SDE. The multiple is related to how attractive the business is for a buyer. To estimate the 1 – 4 range, consider the following aspects:
- Brand and reputation;
- Recurring revenue;
- Financial records;
- Ease of transition;
- Recent performance.
Rate each of them with 1 for lowest and 4 for highest.
5. Calculate an Early Estimate
Depending on the grade of attractiveness you rated in the key areas, you can multiply the seller discretionary earnings by the estimated earnings multiplier. In this way, you can obtain a preliminary estimation of the business purchase price.
However, keep in mind that this is just an estimate and not the final price. There are various factors for which the price estimate will be adjusted. For example, you may not be the right person to objectively assess how attractive the business is for a buyer. For this reason, you may find it useful to ask for help from outside assessors or intermediaries.
Another reason is the fact that when setting the asking price, you should keep in mind that buyers usually negotiate downward. According to a study, most businesses sold for around 87% of the initial asking price. However, the difficult part is that you must account for this variance without rising the price a lot and reduce the buyer interest.
6. Check the Other Prices
After you decided on an estimated purchase price, you should do some research. First, you need to use some business-for-sale services to check the most recent listings, as well as sales. Check with your own business category, price range, or market area. This will help you have a more accurate idea of what other businesses like yours go for. Think about what makes your business different than the rest. At the same time, remember that what you see are only the asking prices, which doesn’t mean the business was really sold for that price.
Next, you should collaborate with other sale advisors. Ask your broker, for example, or use other industry association contacts. Check for an expertise and see if your pricing estimate is in line with other prices of business sales in your own field.
Here you have an extended explanation of the process, as well as other information:
When learning how to calculate selling price of small business, it’s essential to be flexible. Think about the fact that you can reach an agreement that brings you more profit than a high sales price. For example, you can reduce the price in exchange for a part of the gross sales and you will get more profit in time. At the same time, you should evaluate and try to quantify intangible elements (for instance, the client list).
To sum it up, it’s important to follow the steps above when deciding on how to calculate selling price of small business. If you don’t know exactly what you’re doing, it may be better to ask for help from a broker and a business appraiser. Indeed, they might charge you 10% of the selling price plus a fee, but you may get invaluable help from them with legal and logistics issue.
Image source: depositphotos.com