A question of value

The meaning of life may be mankind’s greatest mystery, but for a business owner the next greatest mystery might be the answer to the question, “What is the value of my business?”

An annual ritual business owners perform when their business has bank debt is the preparation of a personal financial statement for the lending bank. One of the “fill in the blanks” is the value of their business. The variety of approaches, rules of thumb, or guesses I’ve seen owners use to answer this question demonstrate for most business owners the value of their business is unknown.

Value is subjective. Different people have different opinions as to something’s value depending on the time and their circumstances. For example, over the life of a privately owned business the value of that business to the owner is usually too much for any reasonable buyer to pay.

How many times have you heard somebody say, “Everything I own is for sale if the price is right.” If an owner states this about his business he is saying he will sell his business, but only if a buyer is foolish enough to pay more than its worth. It is only when a business owner has a life event (or death event) that he becomes reasonable about the true value of his business so that a reasonable buyer will be interested. This is just one of those facts of life.

On the other side of the transaction, a buyer wants to know how much cash the business generates and the risk that after he buys the business it will continue to generate at least the same amount of cash for him as it did for the previous owner. The more confidence he has that the business will continue to operate at historical levels, the more he will be willing to pay for the business. If he lacks this confidence, a buyer will offer less to buy the business to provide a safety margin in case the business isn’t as profitable as prior history.

When a business owner experiences that life event motivating him to sell his business, he needs to keep in mind that a buyer’s perception of his business determines the price at which the business will sell. Most people understand that a first impression is a lasting impression. If a first impression is negative, that perception may never be overcome. Therefore, the buyer’s first impression of the seller and his business can increase or decrease the offering price.

When buying a business, the first item a buyer requests from the seller is a copy of the company’s financial statements. Before a buyer spends any time looking at a business he wants to know is how much is the business making. What is the bottom line? These financial statements will provide the buyer’s first impression of the business and significantly affect his perception of the risk he will accept if he buys it.

The financial statements communicate to the buyer whether he can believe what the seller says. If the buyer doesn’t trust the financial statements, he will perceive greater risk when buying the business and compensate by offering the seller less to buy the business.

When financial statements are not available when requested because the bookkeeper is behind or are provided but are not accurate, this can communicate to a buyer a lack of credibility and real uncertainty. This is another one of those facts of life.

Quality financial statements are accurate, timely prepared, and almost always prepared by a trained bookkeeper or an accountant. Generally a financial statement prepared by a Certified Public Accounting firm trumps a financial statement prepared by an employee of the company and an audited financial statement gives the buyer the highest level of confidence that the financial statement is trustworthy.

If you are a business owner, a fact you may have failed to realize is that a competent CPA whose advice is implemented can significantly increase the value of your business.

Now that’s a good enough reason to fire your nosy mother-in-law who can’t keep books but enticed you to give her the job because she would work cheap.