Many business owners I work with consistently underestimate the true value of their business. This is because they don’t always perceive all the benefits they derive, other than a paycheck, from their company. Here’s the punchline: discretionary earnings can be the key driver in determining the real value of a small to medium sized business.
Earnings before interest, taxes, depreciation and amortization (EBIDTA) is traditionally considered a benchmark of a company’s profitability. However, when it comes to closely-held businesses, EBIDTA may lead to an under- or over-pricing of a business. This is because:
· It does not represent cash flow.
· It does not show actual cash available to service debt, pay owners’ salaries, etc.
· It’s a multiple that does not account for differing depreciation and amortization methods from company to company.
· It does not include changes to a company’s long-term debt.
· Most importantly, it does not represent the amount of cash available to a potential buyer.
Because of this and the tax-minimizing behavior of most closely-held businesses, the BizEquity Valuation service that we utilize, employs a discretionary earning or actual cash flow measure to determine business valuation. Here’s why:
· Actual Cash Flow is the amount of pretax, cash-equivalent benefits accruing to an existing owner(s) working in the business full-time, and conversely,
· Actual Cash Flow is the amount of pretax cash equivalent available to a new owner working on a full-time basis to use as deemed appropriate, to service debt, pay owner salary, buy new equipment, etc.
Identifying monies spent by a company that fall into the actual cash flow category can be the primary driver of an accurate business valuation. Officer compensation and pre-tax perquisites paid by the company on behalf of owners, need to be recognized. Categories include items like payroll taxes, health and other insurance, vehicles, travel and entertainment, and pension contributions. Generally, once a business is sold, the amounts spent on these items would become available to the buyer to spend as they wish.
Business owners don’t short-change yourself. Regardless of your next strategic actions, growth, merger, succession planning, retirement or sale, having a working knowledge of your business includes a business valuation that you can readily update and monitor. Look at it this way; if you have a 401(k) or other investment plans, you probably check those account values at least once per month. Your business may be your biggest investment and if you don’t have an ongoing credible valuation, how can you reliably plan for the future?
What’s your business really worth? Call or email me today – (805) 635-7200 or [email protected].