If you’re considering selling your business, you may be wondering whether or not you should use a business valuation calculator to determine your asking price. Before you do, it is important to understand the underlying elements that determine business value as well as the pros and cons of using business valuation calculators. 

In this article, we discuss:

• The SDE multiple valuation
• Factors that impact the value of a business
• Whether or not you should use a business valuation calculator

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The SDE Multiple Method of Valuation

There are many different ways to value a business. Some of these include:

• Enterprise value
• Intrinsic value
• Fair market value
• Book value
• Market capitalization
• Discounted cash flow
• Future value
• Market value
• Comparable company analysis

Many entrepreneurs, however, prefer to use the SDE multiple method when conducting a business valuation. Both brokers as well as valuation calculators use this method. 

“The seller’s discretionary earnings are the total benefit the company provides to the owner.”

SDE multiple method

The SDE multiple method states that the value of a business is equal to the SDE times the multiple. 

Business value = SDE x multiple

In this formula, the SDE stands for seller’s discretionary earnings. The multiple is simply a number that is multiplied by the SDE to arrive at the value. We will take a closer look at the SDE and the multiple below. 

SDE

The seller’s discretionary earnings are the total benefit the company provides to the owner. It is similar to income, but it is distinct in several ways. 

SDE are the pre-interest, pretax profits that a business generates before taking into account certain discretionary expenses or income. These include:

• Owner’s benefit or salary
• Noncash expenses
• One-time investments

Because these discretionary expenses are added back to income to determine the SDE, SDE does a better job of evaluating the true money-generating capacity of two comparable businesses compared to net profit, income, or revenue. Typically, a valuation calculator will use profit instead of SDE since SDE is more difficult to determine.

To calculate SDE, start by determining the business’s income from the company’s financial metrics. Then, add back all allowable discretionary expenses. These may include certain income taxes.

Since calculating SDE accurately is extremely important for creating an accurate valuation, it is a good idea to work with an experienced business Advisor, or business broker, throughout the process in order to know which expenses should be added back. 

Understanding the multiple

Regardless of whether you run a small business or a larger company, it is important to understand how multiples work when using a valuation calculator, or getting any sort of valuation. The true value of your business goes beyond totaling up the worth of each tangible and intangible asset. 

The multiple serves to capture objective and subjective factors that play a large role in how much prospective buyers are willing to pay for your business. While two companies may have similar SDE figures, they could have dramatically different valuations depending on their multiple. In the next section, we will take a closer look at some of the factors that can raise or lower a valuation multiple. 

“While two companies may have similar SDE figures, they could have dramatically different valuations depending on their multiple.”

Factors That Valuation Calculators Look at to Determine the Value of a Business

While there are countless valuation factors that influence the overall value of your business, they can often be broken down into larger categories. These include:

• Growth
• Risk 
• Transferability
• Documentation

As a business owner, a valuation serves several purposes. In addition to getting an idea of how much you can expect to sell your company for, an expert business valuation also helps you understand what makes your company valuable. Additionally, it reveals what you can do to improve the value of your business. Althogh each of these areas are critical, a valuation calculator may not be able to accurately account for them.

Understanding these four factors is crucial when it comes to understanding how to improve the value of your business.

Growth trends

All other factors being equal, a business that exhibits strong past and current trends will be worth more than a company that does not. In addition, if your business has clear opportunities for future growth, it will be more attractive to prospective buyers. 

Likewise, strong growth within your industry bodes well for the value of your company. Industry decline or stagnation serves to reduce the value of your business. Typically, a valuation calculator can only roughly account for growth.

“All other factors being equal, a business that exhibits strong past and current trends will be worth more than a company that does not.”

Areas of risk

The more risky your business is, the less attractive (and less valuable) it will be to a potential buyer. 

There are several things that influence the relative risk of your business. For starters, companies that have been around for longer are considered stabler and less risky. In addition, if any part of your company’s success relies on a single point of failure, it will incur more risk.

By diversifying your operations and minimizing single points of failure, you can work to reduce risk and increase your company’s value. A valuation calculator often has difficultly when it comes to accurately assessing risk.

Business documentation

Prospective buyers want to see that your business has orderly and up-to-date documentation. This includes financial statements, standard operating procedures, and documented supply chain relationships. A valuation calculator generally can’t accurately account for a business’s documentation practices.

If you haven’t done so already, you can increase the value of your business by taking the time to create professional documentation.

Transferability

Transferability refers to how easy it is to transfer your company to a new owner without negatively impacting its performance. The easier it is to transfer, the more valuable it will be. 

If your personality or image is tied up with your business, you may have a hard time transferring it to a new owner. Likewise, messy or insufficient documentation also serves to hamper transferability. By addressing these issues prior to selling, you can boost the overall value of your business. 

“By diversifying your operations and minimizing single points of failure, you can work to reduce risk and increase your company’s value.”

Should You Use a Business Valuation Calculator?

The biggest benefit of using a business valuation calculator is that it will spit out a valuation number quickly. Simply input your information, click calculate, and you have an estimate of your business’s worth. 

Business valuation calculators have several drawbacks, however, compared to conducting a thorough valuation. For one, the value will vary depending on which valuation formulas are used. Two calculators may use two different formulas, thus giving you dramatically different answers as to the value of your business. 

Likewise, a valuation calculator, or a market-based business valuation for that matter, may ignore one or more of the many tangible and intangible factors that go into determining the true value of a company. For example, it is unlikely that the valuation formula will be able to accurately capture the quality of your documentation or the transferability of your business. 

By working with an experienced business Advisor, however, you can be assured that your business valuation will include accurate SDE figures and a thorough evaluation of your company’s objective and subjective value drivers. 

When you work with an Advisor, you will receive a more accurate idea of how much your business is currently worth, how it compares to similar businesses, and what you can do to increase its value moving forward.