![\"\"](\"http:\/\/www.financenewmexico.org\/articles\/wp-content\/uploads\/2010\/02\/Wayne-Unze.jpg\" "\\"Wayne")
<\/a>Wayne Unze, Director of Business Brokerage at Maestas & Ward Commercial Real Estate<\/p><\/div>\n
Pricing a business for sale requires evaluating its cash flow\u2014another name for a business\u2019s earnings before interest, taxes, depreciation, amortization and owner\u2019s compensation are subtracted.\u00a0 Cash flow is then multiplied by a number that falls within a range appropriate for the industry and market\u2014a number that takes into account other variables that affect the business.<\/p>\n
But unlike multimillion dollar enterprises, small businesses often find much of their cash flow goes toward the owner\u2019s compensation (salary and benefits).\u00a0 To accurately determine a small business\u2019s true cash flow, its owner\u2019s total compensation package must be removed from the equation to reveal essential operating expenses and thus avoid undervaluing the business.<\/p>\n
The easiest and most widely accepted way to do this is to add all components of the owner\u2019s compensation \u2014 things like health insurance premiums, salary, auto lease and profit sharing \u2014 to the earnings before interest, taxes, depreciation and amortization (known as EBITDA).\u00a0 Other additions might include non-recurring expenses such as one-time moving expenses; however a seller must be able to prove all the cash flow components.\u00a0 This means any expense he maintains is not business-related or is personal compensation must have a receipt or other validating document supporting the claim.<\/p>\n
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This revised cash flow sum is multiplied by 2.0 or 3.0 to arrive at a range of business value; if the resulting number is less than the current value of the business\u2019s assets, the asset value then becomes the company\u2019s true value. The cash flow multiple can be increased somewhat if cash flow exceeds $300,000 and even more when it passes $500,000 since more debt can be serviced at that level.<\/p>\n
Other factors that can influence the value of a business are age and condition of equipment, real estate owned by the company, age of business and history of profits, among other things.<\/p>\n
Here\u2019s a sanity test to employ when trying to decide if a business is fairly priced: After a typical down payment of 30 to 35 percent, the business\u2019s cash flow should be able to retire the balance of the debt while providing the buyer an adequate living wage.<\/p>\n
To illustrate this equation, let\u2019s say ABC Inc. has a net profit of $30,000 on sales of $600,000. For an accurate number of this business\u2019s value, consider that the business\u2019s operating expenses include the owner\u2019s salary ($50,000), his health insurance premium ($5,000), his profit sharing ($20,000) and his leased company car ($7,000 per year). Other cash flow components in the operating expenses include interest payments of $10,000, depreciation of $25,000 and amortization of $3,000. When these operating expenses are added to the net profit, the cash flow of this business is a respectable $150,000. Multiply that number by two or three, and ABC Inc. is worth between $300,000 and $450,000.<\/p>\n
If the buyer put down $150,000 (one-third) on an offer of $450,000, the debt service would be about $4,528 per month on a seven-year payout at 7 percent annual interest (standard terms). After servicing the $54,300 annual debt, the buyer would still have about $96,000 remaining as his compensation package and return on his initial investment.<\/p>\n
Article 123<\/p>\n
Download 123_Avoid Undervaluing Your Business PDF<\/a><\/p>\n","protected":false},"excerpt":{"rendered":" When pricing a business for sale, learn how to accurately determine the business’s true cash flow to avoid undervaluing the business. Continue reading