Article by Roger Schlueter, MBA
These Business Valuation Methods were sent to me by the SBA (Small Business Administration), and supposably will be accepted by SBA in their evaluation of financing for a Business Buyout. I also ran into the exact same document on the internet at www.collin.edu/sbdc/docs/Business-Valuation-Methods.pdf , I think it is a SBDC Document but it is quoted from a book. There are many ways to measure the value of a business, and these are but a few of the methods. As for as I can tell, these are accepted by SBA for the evaluation of financing, for a business buyout.
“BUSINESS VALUATION METHODS
(All Valuations MUST BE based on Historical Data)
I. Adjusted Book Value
Take the Book Value of net worth
-assets not acquired
+liabilities not assumed
+fair market value of assets acquired
+any net worth adjustments
=Adjusted Book Value
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II. Capitalized Adjusted Earnings
First Step: Adjust Historical Earnings
Seller’s Discretionary Last
Cash Flow Year
Net Profit 50.0
+Officer’s salary +70.0
+Discretionary expenses +30.0
-New Owner salary -60.0
Adjusted Profit 90.0
Second Step: Get the adjusted profits for 5 years then do a Weighted Average of the
Adjusting Earnings
Year Earnings Weight Adjusted
95 $ 50 1 $ 50
96 $ 30 2 $ 60
97 $ 70 3 $ 210
98 $ 60 4 $ 240
99 $ 90 5 $ 450
Totals 15 $1,010
/15
Average $ 67 (rounded)
Third Step: Calculate a Discount Rate
Determine T-Bill Rate 5.0%
Determine Offset Risk Rate 12.0%
√ Establish rate of return based on risk
factors
√ Establish rate of return based on general
economy
Determine Offset Illiquidity Rate 3.0%
Total the Rates 20.0%
Fourth Step: Take the weighted average of the adjusted earnings and divide by the
discount rate.
Example:
$67/.20 = $335
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III. Discounted Future Earnings
First Step: Adjust Historical Earnings
Last
Year
Net Profit 50.0
+Officer’s salary +70.0
+Discretionary expenses +30.0
-New Owner salary -60.0
Adjusted Profit 90.0
Second Step: Get the adjusted profits for 5 years then do a Weighted Average of the
Adjusting Earnings
Year Earnings Weight Adjusted
95 $ 50 1 $ 50
96 $ 30 2 $ 60
97 $ 70 3 $ 210
98 $ 60 4 $ 240
99 $ 90 5 $ 450
Totals 15 $1,010
/15
Average $ 67 (rounded)
Third Step: Determine the discount rate
Determine T-Bill Rate 7.0%
Determine Offset Risk Rate 12.0%
√ Establish rate of return based on
< div>risk factors
√ Establish rate of return based on
general economy
Determine Offset Illiquidity Rate 6.0%
Total the Rates 25.0%
Fourth Step: Estimate growth, both real and inflationary (for this example, we are estimating a 5%
growth rate).
Fifth Step: Multiply the estimated earnings for each year by the estimated growth rate until estimated earnings for the next ten years are determined.
Sixth Step: Multiply the adjusted, weighted earnings by the estimated growth (1 plus the growth rate) to determine the estimated earnings for the first year.
Seventh Step: Using the net present value table, multiply the estimated earnings for each year by the factor for the discount rate for each respective year to determine the discounted value of future earnings.
Eighth Step: Total the discounted earnings.
Ninth Step: Determine the residual value by subtracting the growth rate from the discount rate and
dividing the difference into the discounted earnings for year ten.
Tenth Step: Add the residual value to the total discounted earnings.
Year Previous Growth Adjusted Factor Net Present
Year (1+5%) Earnings (25%) Value
Earnings
1 67.0 1.05 70.4 0.80000 56.3
2 70.4 1.05 73.9 0.64000 47.3
3 73.9 1.05 77.6 0.51200 39.7
4 77.6 1.05 81.5 0.40960 33.4
5 81.5 1.05 85.6 0.32768 28.0
6 85.6 1.05 89.9 0.26214 23.6
7 89.9 1.05 94.4 0.20972 19.8
8 94.4 1.05 99.1 0.16777 16.6
9 99.1 1.05 104.1 0.13422 14.0
10 104.1 1.05 109.3 0.10737 11.7
Net Total 290.4
Residual 58.5
Total 348.9
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IV. Cash Flow Method
First Step: Identify Available cash for debt service via rule of thumb, sources/uses, or any other
acceptable method.
Last
Year
Net Profit 10.0
+ Depreciation 5.0
Adjusted Profit 15.0
Second Step: Choose a reasonable maturity and market interest rate for the financing requested.
Years
Fixed Asset Purchases 10
Working Capital 7
17 / 2 = 8.5
Average Maturity 8.5
Interest Rate 12%
Third Step: Reverse-compute the amount of total funds that the cash flow can support given the
maturity and interest rate chosen (using an amortization table or calculator).
Cash flow of $15,000 annually at 12% for 8.5 years is an an
nual debt service for the total amount of $79,696.69 (computed on a monthly payment basis) or $77,295.78 (computed on an annual payment basis).
nual debt service for the total amount of $79,696.69 (computed on a monthly payment basis) or $77,295.78 (computed on an annual payment basis).
Cash flow valuation establishes a range of $77,000 to $80,000.
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V. Gross Revenue Multiplier
Please use the attached table (Top 30 Business by SIC Code) and the following:
• SDC or SDCF = Seller’s discretionary cash flow [same as Method II, step 1]
• EBIT = Earning before Interest and Taxes
• EBITDA = Earning before Interest, Taxes, Depreciation and Amortization
Example:
Last Year’s Sales * Multiplier
Top 30 Type of Business by SIC Code
(Counted from 10/98 to 8/02)
Rank # of SIC Description Rule of Thumb1 or Multiplier
Loans Code
1 1900 5812 Eating and Drinking Places 2X SDCF or 25 – 35% of annual sales
2 405 7231 Beauty Shops 1.5X SDCF or 4X mthly sales + inventory
3 337 7538 General Auto Repair Shops 35% of annual sales, 1.5X SDCF
4 325 5411 Grocery Stores 1 – 2X mthly sales or 11% of sales
5 260 8041 Off / Clinics of Chiropractors 20 – 70% of annual fees + FF & E
6 235 5999 Miscellaneous Retail Stores 25 – 50% annual sales + inventory
7 231 7389 Business Services 63% of annual sales
8 228 8351 Child Day Care Services 2X SDCF or $1500 – $3000/enrolled child
9 175 8011 Off / Clinics of Doc of Med 20 – 40% of annual fees or 1X SDC
10 165 7299 Misc Personal Services 70 –75% annual sales
11 165 5813 Drinking Places (Alcoholic) 40 – 45% annual sales + inventory
12 163 5947 Gift, Novelty, & Souv Shop 4X mthly sales + inventory or 1.5X SDCF
13 142 7991 Physical Fitness Facilities 1 year’s annual revenues
14 129 4212 Local Trucking W/O Storage 5X EBIT
15 127 7379 Computer Related Services 57% of annual revenue
16 124 5531 Auto & Home Supply Stores 35% of annual sales + inventory, FF & E
17 120 5461 Retail Bakeries 4X mthly sales + inventory, FF & E
18 117 0781 Landscape Couns & Planning 1 – 1.5X SDCF + FF & E
19 113 6411 Ins Agents, Brokers, & Ser 100% annual commissions
20 112 7999 Amus & Recreation Services 45-50% of annual sales
21 112 5992 Florists 34% of annual sales + inventory
22 108 1751 Carpentry Work 4 – 5X EBIT
23 105 5541 Gasoline Service Stations 3X EBITDA – business only
24 105 7349 Build Cleaning & Maint Serv 50% of annual revenue or 1.5X SDCF
25 105 8021 Offices & Clinics of Dentists 1 – 1.5X SDCF + FF & E, 50-70% Rev
26 105 4213 Trucking, Except Local 1 – 1.5X SDCF + FMV of fixed assets
27 103 5941 Sport Goods & Bicy Shops 4X mthly sales + inventory
28 99 7215 Coin-Oper Laun & Dry/clean 70 – 100% annual sales or 2.3 – 2.5X SDCF
29 94 7532 Auto Body & Uphols Rep 35% of annual sales or 1.75X SDCF
30 94 5399 Misc General Merch Stores 15 – 25% of annual sales + inventory
31 92 1799 Special Trade Contractors 45 – 55% annual sales
32 90 1711 Plumb, Heating, & Air-Cond 24% of annual revenues or 1.5X SDCF
33 88 5499 Miscellaneous Food Stores 4 – 5X SDCF
34 88 2752 Com Printing, Lithographic 50% of annual sales and inventory, FF & E
1 – 1.5X SDC
1 Source: The Business Reference Guide 2002 tenth edition, by Tom West, 2002.”
Summary – Like I said earlier, there are hundreds of ways to value a business and usually it is what the seller says he or she will sell it for. In that case you need to find a way to show the business is worth the amount you are paying or renegotiate, to lower the price of the business.
Please address any questions or comment thru the Blog or email me at roger@rogerschlueter.com or you can also find more contact info at my Website at www.schlueterfinancial.com