Canopy Law > Company Sales & Purchases > Why business valuation calculators do not work

Why business valuation calculators do not work

It’s true! Business Valuation Calculators do not work! Why? They all make the same fundamental error – relying on a pre-programmed multiplier of annual profit.

How a Business Valuation Calculator will under-value your business?

You may be ready to value your business? Congratulations! But wait, have you already been surfing the online business valuation calculators searching for a rough guide value for your business? That’s OK – but here’s where you went wrong.

Let’s remind ourselves how ALL online business valuation calculators are pre-programmed to produce the value of a business based on profit. Firstly, they ask for your financial information: profit, turnover, overheads, owner’s salary. Secondly, they input these figures into an algorithm. Thirdly, the algorithm suggests a guide value for your business ignoring who the identity of the buyer.

What is the magic algorithm? How does it work? At its heart it is designed to use a multiple of your annual profit. It is based on your historic accounts information. Whereas a smart buyer knows that the true value of a business is in its future potential: “The past was yours, but the future is mine”.

A business valuation calculators values a business based on profit

 

The correct way to value a business

Why do business valuation calculators use a multiplier of profit at all? Because this method can be automated online – it requires no regard to the growth potential of a company. It reduces the valuation to a mathematical guess, usually in order to capture the contact details of a seller.

Business valuation calculators do not have the scope or ability to process information on the client base of the business or the attractiveness of the industry niche to a buyer. They treat business value as an accounting exercise rather than an sales & marketing one.

Don’t settle for the valuation of an online business valuation calculator. You can do better!

How to value a business for maximum gain

For example, a beauty salon in Bedfordshire was making a net profit of £25,000. Using the most popular online business valuation calculator the business owner received a guide sale price between £75,000-£125,000.

Three months later she sold the business for £250,0000.

How? Because the business owner was able to demonstrate a client base with huge potential to the right buyer. The salon specialised in treatments for over 50s. It was a highly desirable business purchase for a chain of female health clubs that wanted to access this client base. The buyer valued the business based on its importance to its own business rather than how it had performed in the past.

Why do business valuation calculators produce such wildly differing results to each other? Because they fundamentally don’t work

How do you value “reputation”?

Business valuation calculators have to guess at the reputation value (or goodwill) of a business. There is simply no data they can ask for that will accurately account for this element of a company’s value. In reality, “brand value” is decided by how much the buyer needs to own that brand – this cannot be predicted in advance by an algorithm.

Yes, folks – business valuation calculators really are as unscientific as that!

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