Business Valuation Pitfalls: What is the True Worth of a Business?

I am often asked how can we determine the true worth of a business.

The first step to this process requires determining the actual profit of a business in the current market conditions.  The second step is to create a value for the current income stream assuming it continues into the future or you may want to look at the profit potential of a business not based on the current business activities.

What is Seller’s Discretionary Income?

In order to determine what the profit actually is for a business you must give a definition for profit.  The business broker community defines the profit as “seller’s discretionary income” (SDI). The amount of money that the seller has control over and is not required to be spent in order to run the business.  Basically what it makes in profit plus what the owner can steal in benefits from the IRS.

This definition is really not complete because it doesn’t tell a buyer what has to be deducted from the “seller’s discretionary income”  to be accurate.

Lets tighten up the definition by adding: “The amount of money that a business generates adjusted to include all cash income, all cash expenses, all unpaid government taxes not accounted for because of the cash income and expenses.  (This includes but is not limited to payroll taxes, workers compensation insurance, sales tax, city sales tax, etc.)”

Then you can do the normal adjustments a broker will do in order to come up with a “seller’s discretionary income”.

You’ll be amazed by how many small businesses are making a profit.  You will stop doing so the minute you adjust the books to reflect all the unpaid taxes.

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