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Valuing it on last year’s profit

 

In this series we look at mistakes business owners make when selling their business. In the first article, we looked at the deadly sin of leaving it too late to sell. Here we look at why you shouldn’t be looking backward but instead looking forward when trying to value your business. This approach can appear risky, but really it is the only way to value a business.

I say that because the classic valuation method most business brokers and valuers use is the Future Maintainable Earnings Method. Yes I said Future. Most financial advisors now start to curl up in fear and trepidation when considering future income. But that is the only way to look at it. Yesterday’s income is just that – History! It can only be a guide at best, and can mislead one as to future performance, unless you believe that the future is going to be the same as the past. It rarely is. The other part of that definition ismaintainable. This forces us to ask the question “Will there be something happening to suggest that the income won’t be maintainable in the future?”

So the way to do this is to properly look at the future, projecting growth history into growth trends and taking a common sense look at where the business, the industry and the economy is heading. The past was written according to what happened then. What does the history point to, in context of what is happening in the business and industryright now? To properly value a business according to the FME method, you need to do enough work and research to answer this question “What is the likely income for the next twelve months, and what is the risk that it won’t eventuate and why” Then you are well on the way to compiling a solid valuation that will stand the test of extreme scrutiny.

 

Tony Arena

Owner @ BCI Business Brokers, 30 years of experience in selling businesses

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