I want to buy an existing hardware store. The owner said to make him an offer, but I'm not sure of the best way to determine the worth of the business. If you found the perfect business in the perfect location, would you have any idea of the business value?
There is a multitude of approaches to value a business. There's no "correct approach.” Ultimately, the business is worth whatever you think its worth, based on the criteria that you and the seller have agreed upon.
Business Valuation Advantage
You might be reaching retirement age and you're contemplating an exit strategy. You'll need to know the value of your business so you can construct a plan. An exit strategy doesn't necessarily have to mean the sale or closing of a business.
It could mean restructuring. In any case, a valuation can help determine the owner’s exit strategy.
Most experts agree that the starting point for valuing a small business is to normalize or recast the business’s earnings to get a number called the “Seller’s Discretionary Earnings (SDE).” SDE is the pre-tax earnings of your business before non-cash expenses, owner’s compensation, interest expense and income, or one-time expenses that aren’t expected to continue in the future.
Small businesses owners report expenses on their tax returns with an eye towards reducing their tax burden. Business owners likely claim many deductions that lower your business income on your tax return. This is why using income numbers from a business’s tax return can underestimate how much revenue the business actually produces.
SDE gives business owners a better idea of the business’s true profit potential by calculating the what the business’s earnings would be with a potential new buyer.
This is done by adding back in expenses listed on your tax return that aren’t necessary to run your business. These ad-backs includes your salary as the business owner and any one-time expenses that aren’t expected to recur in the future.