How do you value a business based on turnover?
Business valuation is often a complex process that involves taking into account: financial performance, sector, market interest and a variety of factors related to how your business is run. That may sound like a lot of work…
Well, if you’re looking for a shortcut that will give you a general idea of how much your business could be worth, sales-based valuation may be for you.
If you’re interested in how to value a business based on turnover alone, it could give you an idea of how much a business is worth.
This post will give you:
- when the turnover valuation method is a good idea,
- the formula for valuing your business based on turnover,
- how sales-based valuation could be affected by other factors,
- the valuation process in action with an example of how a company can be valued based on turnover.
When is business valuation based on turnover a good indicator of company value?
Turnover is a good indicator of how popular your product is. Unfortunately, it says little about your costs, investments and how efficient your operations are.
Still, sales-based valuations have their place. If you have a relatively new business, you may not have a set of company accounts yet. You may not have run through a full 12 months of normal overheads yet. Your circumstances may prompt a need for a business valuation. This is where a value assessment based on turnover can fulfil that need.
In addition, this valuation method tends to work best for businesses with an uncomplicated setup. As such, it works particularly well with smaller high street, retail-style businesses. These are often the stereotypical small business where many entrepreneurs take their first steps in business ownership.
The formula for valuing a business based on sales
The starting point of turnover based valuation is the average weekly sales. To get that figure, take your total turnover to date for your current financial period. If available, add your turnover for previous financial period too. Then, divide that sum by the number of weeks in that period. When calculating your average weekly sales, exclude VAT.
If you find out your average weekly takings over a period of time, this will leave out seasonal changes in performance as well as other extraordinary circumstances. It will level out one-off incidents which may have positively or adversely affected trade.
Next comes a tricky part of the valuation. This is not exact science, but rather a method developed by having an experience with businesses in various sectors. Once you have your average weekly turnover, you have to decide how many weeks of that turnover equate to a fair value for the business. This is usually sector specific, below are some examples that we’ve worked with in the past. Weekly multiples will depend on the quality of the fixtures so the actual numbers might vary slightly.
- Convenience stores – x8 weeks if gross profit is over 20%, plus 5 weeks lottery takings if you sell lottery tickets;
- Traditional greengrocers – x10 weeks;
- Hair & beauty salons – between x10 and x15 weeks depending on the quality of the fixtures and fittings being left in the business;
- Cafes, takeaways – x20 weeks;
- Restaurants – x30 weeks of turnover.
Once you multiply your weekly turnover by the sector value, you’ll get your business valuation based on turnover. Here is the full formula to use:
(turnover / number of weeks) * sector multiple = business valuation
How sales based business valuation differs from a professional valuation
Once you get your value, you still need to consider how realistic it actually is.
Consider the following situation:
A newsagents would be valued in a similar way as a convenience store, so with an average weekly turnover of £6,000 and applying an 8x multiple to the weekly takings, its turnover-based value would be £48,000.
If that newsagents was in close vicinity of a supermarket that also sold newspapers, the newsagents as a business would look less attractive to potential buyers. If the shop had a dated design and fixtures that had not been maintained and updated properly with poorly-stocked shelves, the venture would be less attractive still. All these factors could bring the actual value of the business down as buyers would likely drive the price down as they evaluate their opportunity.
When valuing a business for the purpose of selling it, you need to consider other factors that will make the business more or less attractive to potential buyers.
How to value a business based on turnover – a real-life example
Sometimes, sales-based valuation could be a good place to start, provided that you then take into account additional factors that may affect the final price.
A few years ago we valued a coffee shop. It was in an off-high street location in a medium sized town. Whilst not in the main thoroughfare, it was on the walking route between the town centre and a large business centre. That meant many people passed the doors each lunchtime. The premises were well decorated and spacious. The café served tasty food and cakes in addition to well-liked coffees and teas. It was a thriving business – but due to an unforeseen change of personal circumstances the owners were being forced to sell it.
The business was approximately 18 months old and we had just one set of accounts to evaluate. With it being a start-up, the first year had many costs associated with setting up and fitting out the shop. This first year’s accounts contained all those exceptional set up costs. Whilst the business had grown quickly and was popular, it still reported a loss in that first year.
On the other hand, in more recent months, the turnover was picking up as the shop’s reputation for quality, cleanliness, value and atmosphere had grown.
In theory, we could value the business based on the total turnover. Here is what we’d achieve:
In those first accounts, annual turnover hit £100,108 with a small loss of £5,104.
Using the turnover valuation method, the calculation would be as follows:
£100,108 / 52 weeks = £1,925 (average turnover per week)
Average multiple for a café is 20, hence:
£1,925 x 20 = £38,500
Based on these traditional sales-based valuations, the business would be valued at £38,500.
As business brokers, we know that the formula needed to be amended to reflect a more realistic view of the business value. Indeed, more focus should be given to how the business has been running more recently. These recent months show stronger indication for future performance. Our professional valuation looked at the most recent growth trends and cost management. It also included factors like outside catering contracts and the income they will provide for a new owner. That income was not included in past turnover but did have a considerable value.
After taking all these factors into account, we selected a shorter and recent period to value against. Our professional evaluation was £45,000 and this was the price the owners were able to sell the business for within 5 months of advertising it. This made a significant difference to the business owners, allowing them to benefit from the sale more. The additional £6,500 achieved between the value from turnover and the full broker evaluation paid our clients’ professional fees of the sale (accountant, solicitor, landlord and ourselves) – with cash to spare.
If you need a business valuation for the purpose of selling it, turnover method can be a good place to start. However, if you’re committed to getting an accurate price that will reflect your best interests and what potential buyers are likely to pay, it’s worth taking the time to consider all factors that may play a role.
One of the most critical parts to selling a business is the ability to present it well. If you have the ability to confidently provide answers to any questions a buyer brings to you, it will build trust and the buyer will feel more confident about the accuracy of the valuation. The negotiation process is a careful undertaking with the aim of reaching a consensus that all parties will be happy with.
By examining the detail of a business to work up a thorough and professional evaluation, you can learn the key elements of what makes a business successful. You can also learn what will continue that successful course and where there may be any issues.
Being able to understand a business, and then to communicate it effectively to a buyer can only come when you spend time on a full evaluation to begin with. Maths alone won’t achieve this.
If you’re curious about how much your business is worth, why not find out if you’re eligible for a free professional business valuation? Three out of four businesses qualify and we take our time with each business to understand all the factors before coming up with an estimate.