There are basically two parts to valuing a business. The qualitative part deals with nature of the industry, competition and customer base. The quantitative part deals with potential earnings and capital invested. We will deal with both the aspects.


A business can be valued either on the basis of its assets and/or possible future earnings or a combination of both. Valuing a business on the basis of its assets means just that - make a list of all the assets, land, building, machinery, tools, stocks, receivables etc. Receivables and stocks are valued at its current cost, Machinery and tools are valued at its replacement cost based on its condition, life expectancy etc. Land and Buildings are valued on the basis of current market values. Intangibles such as goodwill are valued on a basis of x number of years earnings potential. A business may also have a customer list that it has nurtured over the years. This can also be valued on the basis of possible earnings using that list to continue and sell the same products. One could also explore sale of other products through the same channel.


A business can also be valued on the basis of cash flow. If a business has predictable cash flows, it could be valued by determining the present values of the future cash flows. Let us assume that you are

interested in buying a car wash. The car wash could have potential earnings of $100,000 every year. Let us further assume that the owner is asking you for $400,000.At the end of 10 years, you may be able to sell the car wash for $400,000, the same amount that you paid for it. The first step is in determining discounted cash flows. Let us try and understand discounted cash flow. Stated simply, a dollar today is not the same as s dollar after a year. A dollar today is more valuable because of the element of interest on it. We will use a risk free rate of 10%. Year1 - DCF is calculated as $100,000 divided by 1.1 - the .1 is the interest element at 10% - value is $90,909, Year 2 is $82,645, Year 3 is $75,129, Year 4 is $68,270, Year 5 is $62,000 and so on. The Discounted cash flows for the predictable earnings using a risk free rate of 10% is $613,356. The present value of the $400,000 that will be realized by sale of the car wash is $153,129. So, the total gains over 10 years are $766,485 ($613,356 plus $153,129). Stated differently, the seller is asking for $400,000 for something that will earn you $766,485 - a discount of 48%. A word of caution here - the entire value depends on predictability of cash flows.


On the qualitative side, one has to examine factors such as number of years in business, training required for the buyer. whether there are any key employees whose presence is very important, regulations on the business, technological factors and so on. The buyer should also examine the level of competition. Finally, any business to survive needs a USP - unique selling proposition that differentiates it from other businesses in the same field - it could be quality, timeliness in deliveries, add ons provided, or any such similar differentiator.