Some people just want to know a “quick and dirty” method to value an Odessa business for sale. Despite all of the information literature about valuing a business for sale, not everyone has the time or money to go through the formal business valuation process. A rules of thumb method may be a good indicator for how to value a business for sale in Odessa.
The rules of thumb method is simple to understand and apply. Often, they are a lot more accurate than many people may think. They may supply a quick assessment, but if used properly, they can come pretty close to what the Odessa business will ultimately sell for.
Rules of Thumb
The International Glossary of Business Valuation Terms defines the rule of thumb as “a mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry-specific.” Rules of thumb usually come in two formats to value a business for sale in Odessa. The most commonly used rule of thumb is simply a percentage of the annual sales, or better yet, the last 12 months of sales/revenues. For example, if the total sales were $100,000 for last year, and the multiple for the particular business is 40 percent of annual sales, then the price based on the rule of thumb would be $40,000 ($100,000 x 40%).
The second rule of thumb used is a multiple of earnings. For most Odessa businesses, the multiple is used against what is termed Seller’s Discretionary Earnings (SDE). SDE is also called Seller’s or Owner’s Cash Flow and similar names. It is usually based on a multiple (generally between 1 and 5), and this number is then used as a multiple against the earnings of the business. Rules of thumb for earnings also include earnings before interest taxes depreciation and amortization (EBITDA), or EBIT.
Understanding the various market multiples will go a long way to answering the question of how to value a business for sale in Odessa. SDE, however, can be a bit confusing. SDE can be calculated by applying the following adjustment to the income statement:
- Net Income
- Plus: taxes
- Plus: non-operating (essential) income and expenses
- Plus: non-recurring income and expenses
- Plus: depreciation and amortization
- Plus: Interest Expense
- Plus: Owner’s total compensation for one owner/operator, after adjusting the total compensation of all owners to market value
Keep in mind when applying the rule of thumb method to value a business for sale in Odessa, that multiples for the different earnings acronyms mentioned above will be different than the multiple of SDE. The rules mentioned from various sources are specific to what is being used. They will indicate 2.5 times SDE or 4 times EBIT, etc.
Using the rule of thumb method to value a business for sale is straight forward and easy to apply. To get the best indicator of value, apply as many multiples as possible from as many sources as possible.
Sources & Other Topics
The Business Reference Guide (BRG) is a solid source you can rely on to apply the rules of thumb method. Out of all of the available options, it is probably the cheapest. The BRG is published and updated annually in book or electronic form. The book comes in under $200 making it an affordable option to get a quick and dirty number for a business for sale in Odessa.
The price, based on the rule of thumb in the BRG, does not include inventory (unless it specifically states that it does), or real estate and other balance-sheet items such as cash and accounts receivable. Keep in mind that cash, accounts receivable, and work in progress (WIP) do not generally transfer in the sale of an Odessa business. This means that the prospective buyer (you) will have to “put in” working capital on day one since the company won’t have any cash to fund operations. Working capital is constantly a moving target and is generally the last item to be reconciled on the actual day of the transaction.
What value does the rules of thumb method calculate? When applying this method to value a business in Odessa, the rules of thumb method calculates a price that includes goodwill; furniture, fixtures, and equipment (FF&E); and leasehold improvements, less outstanding debt, including accounts payable, loans on FF&E, bank loans, etc. The Odesa business value, unless otherwise mentioned, is assumed delivered to a purchaser free and clear of any debt or encumbrances.
If you valued an Odessa business for $1.0 million, how much does the seller get? Theoretically, the seller would get $1.0 million minus the working capital target. However, the seller would not receive a $1.0 million check. If the Odessa based business had $100,000 in cash and $50,000 in accounts receivable (which the owner takes with them), then the final sale price would be $850,000 less than the working capital target and any broker commissions (if necessary). Often, the seller believes they are getting the $1.0 million check plus cash and accounts receivable, but that is not true.
A Word of Caution
The National Association of Certified Valuators and Analysts (NACVA) provides insight into the value of a business, business ownership interest, security or intangible asset. However, the value indications derived from the use of the rules of thumb should not be given substantial weight unless they are supported by other valuation methods, and it can be established that knowledgeable buyers and sellers place substantial reliance on them.
The rules of thumb, from an experienced valuator perspective, is used to corroborate other values applied using professional judgment. This method, while valid to provide an initial indication of value for an Odessa business for sale is not a valid methodology by itself. An experienced business appraiser in Odessa understands that the value of a business can be substantially different than the value indicated when using the rules of thumb method. To understand more about how to value a business in Odessa, call a representative today at Caprock Business Consulting.
