What is a small business really worth these days?

As a business broker and evaluator, I’m often asked what a business is worth. The appraisal of privately held businesses is not an exact science, but there are guidelines that can be used for a close approximation of value

The two basic methods of quickly approximating value are: (1) applying a multiple to the discretionary cash flow of the business and (2) applying a percentage to the annual gross revenue of the business.

The most accurate of the two guidelines involves discretionary cash flow, but there must be an understanding about what that is. It is NOT the profit or loss that you show Uncle Sam on your tax return.

Simply stated, almost all small business owners run some expenses through the business that are not absolutely necessary to the operation of the business. Discretionary cash flow is the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses.

Another way to define discretionary cash flow is that it is the “total owner’s benefit” derived from owning the business, regardless of how the owner takes the money out of the business. It is the amount of cash left over after necessary expenses that is available for (1) owner’s remuneration, (2) return on investment and (3) debt service, if any.

Almost all privately held businesses will appraise for somewhere between one to five times discretionary cash flow, or DCF. Exactly where in this range that a specific business falls depends on the type of business.

For example, we know that a coffee shop is valued at approximately two times DCF. A health food store is worth about 1.5 times DCF. Home health care is four times; janitorial services at 1.5 times; jewelry stores are five times. Manufacturing operations will sell for between three and five times DCF depending on several factors. Wholesale distributors in general are valued at around twice the DCF.

A less accurate method of estimating the value of a business is to apply a percentage to the company’s annual gross revenue. For example, a full service restaurant with a liquor license will be worth approximately 30 percent annual gross revenue if it’s earning the average bottom line profit for its peer group.

As other examples, dry cleaners will be worth approximately 70 percent of annual gross revenue and book stores will appraise for about 15 percent.

None of these appraisal guidelines includes the value of any real estate or inventory on hand. If the business owns real estate, the value of the realty should be added to the guideline result. And inventory for resale, at cost, should also be added to obtain the total estimated value of the business.

However, you as the owner, seller or buyer of the business are the final arbiter of what the business is worth to you. Remember, these guidelines are only averages. And the guidelines certainly don’t take into account any future plans that an owner might have. What a particular business might be worth to you may be more or less than it’s worth to the next person who looks at it.

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