Every business starts out as someone’s dream. But while dreams may be priceless, businesses require an accurate valuation before buying or selling. Arriving at a total picture of a business’s value involves quite a bit more than just profits and losses. In fact, to really understand a business’s price tag, we need a 3-dimensional approach, examining its past, present, and—most importantly—future.
For both buyers and sellers, a business’s potential ultimately determines its price tag. But potential can be difficult to determine from a ledger alone. If you’re in the market to buy or sell a business, consider these top valuation factors when determining a fair price.
Despite its reputation as one of the most basic metrics by which to judge a business, revenue can tell us a lot about a business’s potential for growth. One fiscal year may show a profit while another shows a slight loss, but all in all, a 3-5 year picture of steady revenue growth demonstrates an aptitude for future earnings.
As a new business owner, you may be able to invest something different into a business in order to maximize a profitable trend. Conversely, as a seller, your years of steady revenue growth prove the viability of your business and can only improve your final asking price.
Loyal customers, like a good reputation, cannot be easily purchased. A business’s existing customer base illustrates not only a default client list for new management on day 1, but it can also help new owners to better understand historical revenue trends. There is, however, a flip side to this factor.
The more a business relies on a handful of loyal customers, the more perilous that business’ position may be. If, for instance, one or two top clients cut ties with a business after it changes hands, how will that affect revenue and operation? Which clients are responsible for the largest percentages of revenue, and what will happen if they’re lost?
While loyal customers are valuable, it’s the number of new customers that better represents a potential for growth. Both customer bases are crucial in their own right, but a healthy ratio of both new and old customers says the most about value.
If you look at revenue alone, you may not be getting the whole picture. To understand how profits are working for a business, you need to examine cash flow.
Cash flow pertains to the amount of money coming into and going out of a business. There are several key cash flow categories describing the types of money involved, including operating, investing, and financing cash flow. Businesses that can cover these categories with existing revenue have a positive cash flow while those that can’t have a negative cash flow.
Some businesses might boast about excellent revenue even if they struggle to cover operational expenses, investing losses, or debt payments. Conversely, businesses with only moderate revenue may have a strong enough positive cash flow to justify a higher sticker price.
The National Economy
The COVID-19 pandemic resulted in stunning economic side effects in industries across the board. While many types of businesses were able to weather the storm, others weren’t so lucky.
Understanding how the national economy plays into business valuations is as simple as imagining a restaurant being put up for sale in early March of 2020. Plainly stated: periods of economic bust or boom will have an immediate impact on the asking price.
In lean times, a business valuation is likely to sink under buyer caution and market uncertainty. The opposite is, of course, also true. While not applicable to every industry, the state of the national economy is likely to have an affect on your valuation. It’s important to keep in mind the “What” and “When” of business sales—what type of business are you buying/selling, and when are you planning on buying/selling it?
Bring in Expert Help
A total list of important business valuation factors would number well into the dozens. The ins and outs of understanding a business’s value are complicated, and we may not always grasp the 3-dimensional truth of a promising new venture on our own. With so much money and hope on the line, it may be best to bring in an expert CPA.
An expert CPA can scrutinize metrics like revenue, customer base, cash flow, and the current economic moment to arrive at a more complete understanding of a business valuation. When negotiating the final price, a CPA can arm you with the information you need to make the best deal and decision possible.
Every business starts out as someone’s dream. How that dream ends or begins—for sellers and buyers—depends on an accurate business valuation.
For more about CPA business valuation services, Contact Aldridge Borden and Co. today!
As a seller, your years of service and dedication demand a fair price. As a buyer, paying more than you need to for a business can start you out on the wrong foot. Expert guidance from an Aldridge Borden CPA can help balance the scales with in-depth analysis, cutting-edge metrics, and pinpoint-accurate research. If you’re in the market to buy or sell a business, call (334) 518-6413 today!