How to Calculate the Value of a Business

How to Calculate the Value of a Business

When contemplating the sale of your business or succession planning, it’s important to understand how to calculate the value of a business in relation to the actual cash return it will provide to you, the owner.  To that end, I’m going to share two examples of how the sale of a smaller business unfolds for an owner, by the numbers. Today’s example is describes a business with annual sales of $2.5M and next week I’ll share an example of a larger business.

*Note: the examples below put each of these cases into a highly favorable light. In reality, most businesses will have made decisions in the past that will inhibit them from getting these results.

Sample One – Smaller Business

Assumptions:

• Annual Sales – $2,500,000
• One Owner – Compensation of $150,000
• Business Free Sustainable Cash Flow – $250,000
• Tax Rate on Sale Proceeds – 25%
• Earnings Rate on After-Tax Proceeds to Fund Lifestyle – 5%

How it unfolds:

• Valuation of Business at 4 Times Cash Flow = $1,000,000
• Tax on Sales Proceeds = $250,000
• After-Tax Proceeds from Sale = $750,000
• Earnings at 5% = $37,500!
• Loss of Lifestyle = $112,500…A 75% Hit!

If you’re curious about how your own business may be able to fund your retirement, the free Business Valuation Calculator on this site is a great way to quickly and easy crunch your own numbers right now.