Scenario: I am looking to buy an existing coffee shop. The owner said to make him an offer, but I’m not sure of the best way to determine the worth of the business.
Tips: You can start by looking at the value of the business’s assets. What does the business own? What equipment? What inventory?
you’d have to buy all the same stuff if you were starting a coffee shop from scratch, so the business is worth at least the replacement cost. The balance sheet can give you a good indication of the value of the company’s assets.
The other valuation approaches all think of a business as a stream of cash. They value a business by trying to come up with a value for that stream of cash.
Revenue is the approximation of a business’s worth. If the business sells RM100,000 per year, you can think of it as a RM100,000 revenue stream. For instance, a business might typically sell for “two times sales” or “one times sales.”
That’s why earnings matter and why multiples of earnings may be a better way to think about valuation. Estimate the earnings for the next few years and ask how much that income stream is worth to you.
Be careful, don’t just assume earnings will be stable. Think about the competition, supplier price changes and a declining industry can affect earnings. Make sure to reflect that in your projections.