Business valuations – part 1

June 20, 2017

To paraphrase Tom Hanks from A League of Their Own, if business valuations were easy, everyone would do it. I would also need to find another job.

Why is it that there are more than 3,000 accountants in Victoria and only 25 CA BV (Business Valuation) Specialists?

Certainly the formula for valuing a privately owned business is pretty simple and goes something like this:

Business value = Profit x Multiple

For example:

  • Profit = average profit over the last three years of $500k
  • Multiple = 3 times
  • Business value = $1.5 million

Voila, hey presto, job done. A swing and a miss…

What seems simple doesn’t always get done right.

Starting with the profit in the formula:

  • Which profit do we use? Pre-tax, EBITDA, EBIT, net profit after tax?
  • Which financial year do we use? The year just finished? Next year?
  • Should I take an average? What about a weighted average?
  • Do I adjust profit for one off items, called normalisations?
  • Which normalisation adjustments are relevant?
  • How do we treat the owner’s salary (or lack thereof)
  • What do we do with non-cash items like depreciation?

Best way to think of this is that we are estimating future profit. If I am buying your business, then I will pay you for what I believe it can achieve next year. Who cares what happened three years ago.

Take an example:

What if you are the business owner and are selling your business?

What if you were the buyer?

I will talk about the ‘multiple’ in the formula next time…

Lachie

CA BV Specialist