According to the broker’s advice to Tom, a five year return on investment for the buyer was the simplest income based method for determining the value of the business. The average business buyer, one can assume, typically wants their money back within the first five years of purchasing the business. In short, this income based formula considers profits and salary potential over a five year period.
As a business owner, you probably pay yourself a salary. A healthy business earns a profit over and above your salary. A percentage of these profits, for a healthy well-planned business, normally would be re-invested in the business for equipment upgrades, training, or any number of business improvements. The last five years’ worth of your salary plus profits should provide the five year return on investment figure for your buyer, thus determining your business’ indicated value and reasonable sale price.
(annual salary + annual profits) x 5 years = business value
$60,000 annual owner’s salary + $32,000 annual profits = $92,000 discretionary income
$92,000 annual discretionary income x 5 years = $460,000 estimated business value/sale price