Economy
Related: About this forumHow does one go about establishing the value of a company?
Let's say that a hypothetical company has $ 125,000 as a gross income, and then after adjustments, it has a $ 50,000 net income.
What is that company worth? Is it worth $ 50,000 or twice that or three times that? (Assuming no large outstanding debts, or lawsuits against it.)
Sherman A1
(38,958 posts)it is worth what someone else is willing to pay for it. I am sure there are formulas that will help you establish the valuation, but even with those there are variables which include seasonality of the product or service, goodwill, name recognition and many intangibles.
merrily
(45,251 posts)earnings have the most to do with it, or should.
More minor point. If it is a closely held, and smaller business, you also have to back out some of the kinds of compensation to the major stockholder(s) that another employee might not be able to demand successfully.
truedelphi
(32,324 posts)Thank you.
merrily
(45,251 posts)merrily
(45,251 posts)see it as objective. IMO, the choice of what is considered an appropriate multiple is very subjective, but I hasten to add that not many say that flat out.
http://www.investopedia.com/terms/p/price-earningsratio.asp
There is a lot more about valuation of a business on the net.
truedelphi
(32,324 posts)Shrike47
(6,913 posts)truedelphi
(32,324 posts)Until doing a google search.
And this particular business has a whole lot of good will attached.
merrily
(45,251 posts)$50K times a multiple. Choosing the appropriate number for a multiple is where most of the complications (and, IMO, most of the subjective stuff) come in. Also, you value differently for different purposes. Liquidation value is different from going concern value is different from insurance value and so on.
And, if you are asking because of a family dispute of some kind, oy is all I can say. I know of family battles over value that went on for over ten years, with each side hiring its own accountant, whose valuation coincidentally favored the side that had hired that accountant, and not being able to agree on the identity of a tie breaking accountant.
I don't think this is the kind of question where posing it vaguely is going to elicit useful answers. The kind of business it is, the size of business it is, the reason a valuation is sought, etc. all affect a half way useful answer. With respect to all my fellow posters, this may not be a situation in which a poster's answer is going to help you much.
truedelphi
(32,324 posts)And at this point, the more the merrier. I am throwing "spaghetti ideas" against the ceiling until one or two hit. All ideas are taken with the proverbial "grain of salt" so there is that side of it too. (With these metaphors, you might think I am talking about an Italian restaurant as my business. But it is publishing related.)
And no, it is not a family dispute. Simply a need to grow the business.
merrily
(45,251 posts)If it's a loan at issue, the lender will value and then discount some.
BillZBubb
(10,650 posts)One easy, yet fairly good way is to use the Price/Sales ratio. With the P/S ratio, if you have a company without a lot of assets that is profitable and with a reliable market and not much debt or other liabilities, ONE TIMES SALES (revenues) is a safe, conservative valuation for a company. It can be a bit higher for goodwill, etc.
If sales growth is above the growth of the economy the Price to Sales multiplier goes up accordingly. Unless it is a growth business, a P/S above 2 is too high.
So your valuation using net income isn't too far off.
merrily
(45,251 posts)BillZBubb
(10,650 posts)But it is a very good starting point.
merrily
(45,251 posts)But maybe not such a good starting point if you are trying to calculate how much you should sell a portion of the company for. Or if you are deciding on the amount of "key man" insurance you should buy, or how much of a loan to request from a bank without seeming either ridiculous or too conservative.
Of course, no matter what, you are going to start with earnings (and saying one times earnings is only another way of saying that).
BillZBubb
(10,650 posts)ONE TIMES TOTAL REVENUES. Not one times earnings.