Business evaluation in USA

F or example, if you value a hair salon, where service, location and reputation are important, the value of any goodwill would have to be added to net assets to get a valuation. Goodwill may or may not be transferred if you buy a business, since it can come from physical features like location, or from personal factors, like the owner’s reputation or relationships with customers or suppliers. If a business is underperforming and has no goodwill, then using net asset valuation could be an accurate way to value it. Capitalised future earningsWhen you buy a business, you’re buying its assets and the right to all profits the business might generate. C apitalising future earnings is the most common method used to value small businesses. I.

t considers the rate of return on investment (ROI) that you can expect to get from the business. How it works? Work out the average net profit of the business over the last three years using its profit-and-loss statements, adjusting profit for one-off expenses or other irregular items each year;Decide on the annual rate of return you’re looking for (e.g. 20 per cent) There are no rules about the number you choose, except higher risk should give higher returns;Compare the business with other investment opportunities;You can also look at the rate of return that similar businesses in your industry achieve;Divide net profits by the rate of return to determine the value of the business, then multiply by 100. ExampleDavid is looking at buying a bakery business with average net profits of $ 100,000 per annum after adjustments. D avid wants an annual rate of return of 20 per cent. T hecapitalisedearningsvaluationis: David will pay $ 500,000 now for a business he believes will earn $ 100,000 a year plus 20 per cent more profit each year into the futureEarnings multipleMultiply the business' earnings before interest and tax (EBIT) by your selected multiple. For example, you might value the business at twice its annual earnings — so a business with an EBIT of $ 200,000 might be valued at $ 400,000. T he multiple you choose will depend on the industry and the growth potential of the business.

A service-based business might be valued at as little as one year’s earnings, while an established business with sustainable profits might sell for as much as six times earnings. Comparable salesWhatever other valuation method you use, you should also look at prices for recent sales of similar businesses. R esearch what’s happening in the market you’re interested in. S peak to business brokers and gauge their feelings about the business' value.

A broker may know what similar operations are selling for and how the market is placed. C heck business-for-sale listings in industry magazines, newspapers or websites. Economic profitSuppose you knot socks for a living. Y ou hire two people to help you, buy three knitting machines, and run the operation from a warehouse your grandmother gives you. T he following is a list of your monthly «out-of-pocket» explicit costs, which total $ 4,000:Yarn$ 400Labor2,800Wear and tear on machines600Electricity150Miscellaneous expense50Total4,000If the total revenue from sock sales is $ 9,000, the accounting profit would be a very nice each month.

A ccounting profit is simply the difference between total revenue and explicit costs. What is missing from the list of costs above? F irst, you have listed nothing for the rental value of the building your grandmother has given you, an implicit cost.

I f warehouses like the one you are using can be rented for $ 2,000 per month, you are giving up that much rent to make socks. T his implicit cost may not show up on your books, but it is a very real cost just the same. A second implicit cost missing from the list, is the income you could earn if you worked in some alternative job, instead of your own business.

Y ou must be compensated for the opportunity cost of your labor. I f you could earn $ 2,000 monthly in your next best alternative job, that amount is also an implicit cost of working in your sock-knitting business. Finally, you are performing the entrepreneurial functions of innovating, taking risks and incurring the headaches of organizing your business and hiring others. Y ou also must be compensated for this activity, since enterprise is a scarce resource. Y ou could use your entrepreneurial ability to start up an alternative business, such as making bicycles or selling mail-order retail goods.

T he normal return to entrepreneurs in those businesses is an implicit cost of undertaking the sock-knitting concern. T hat is, if entrepreneurs in those alternative businesses normally make about $ 1,000 monthly for their enterprise (not for their labor effort), the amount is an implicit cost of doing the business. Economists call this normal return for enterprise a normal profit. S.

ince entrepreneurs must receive at least a normal profit to stay in a particular business that amount of profit as an opportunity cost and must be included in implicit costs. C ombining the $ 2,000 rental value of the building you own, the $ 2,000 in wages forgone, and a normal profit of $ 1,000, your total implicit costs are $ 5,000. N.

ow, let’s count the total costs of operating knitting business: Explicit costs: Yarn$ 400Labor2,800Wear and tear on machines600Electricity150Miscellaneous expenses50Total explicit costs$ 4,000Implicit costs: Rental value of warehouse$ 2,000Alternative wages lost2,000Normal profit1,000Total implicit costs$ 5,000Total economic cost$ 9,000Economic profitis the difference between total revenue and total economic cost. I f revenue and economic cost are equal, the firm makes zero economic profit. I f revenue exceeds economic cost, the firm makes an economic profit, and it makes economic losses if revenue is less than economic costs. With total revenue $ 9,000 your accountant would say you are earning a monthly accounting profit of $ 5,000 (revenue $ 9,000 — explicit costs $ 4,000). A n economist, however, would say you are earning zero or no economic profit because your revenue is just sufficient to cover your total economic cost. Y.

ou are only earning a normal profit. Economic profit is an important concept because it is the primary determinant or whether new firms decide to enter an industry and whether existing firms continue to produce or leave the industry in the long run. W hen economic profit is zero (a normal profit is being earned), the firm is an equilibrium. T he firm has no incentive to change its price and output policies.

W e assume that the firm is already doing all it can to keep costs low and revenue high. N or is there incentive for other firms to enter this industry and compete, since only a normal profit is possible. When economic profit is negative (economic losses), the firm will go out of business, switching its resources to other industries where at least a normal profit can be earned. W.

e should note that accounting losses are not necessary for this happen. A firm making an accounting profit may not take a normal profit since no implicit costs are included. W ithout at least a normal profit the firm will close in the long run. F irms in competitive industries produce efficiently. P.

roduction efficiencymeans that competitive firms produce and sell their output at the lowest possible cost in the long run, or price is equal to minimum average total cost (P = ACmin). S o, that means that consumers are guaranteed that price will be equal to the lowest possible production costs. The pure model of competition also guarantees allocative efficiency, which means that resources are used in a way that reflects consumer preferences. CONCLUCIONThe American economy model is becoming very popular all over the world. E conomics is studied in universities in all parts of the Globe and business evaluating practices became common all around the world.

T his happens for two reasons. A t first, the rules of economics proved to be true and workable. T he second reason is that the heritage and experience of operating enterprises in the economy to which all other countries move forward is very precious.

N obody wants to make mistakes and operate a business being blind. O ne of the important concepts for business evaluation is economic profit. I t is the primary determinant or whether new firms decide to enter an industry and whether existing firms continue to produce or leave the industry in the long run.

A nother concept is capitalising future earnings. I t is used to value small businesses. I t considers the rate of return on investment (ROI) that you can expect to get from the business. A.

mong the others is asset valuation method. The most promising and contemporary method of business evaluation is total cost management (TCM). T his process is based on broadly accepted principles of product cycle and it applies to all industries. I t can be used by all levels of businesses and in all areas, academic, and institutional environments (customers, subcontractors, government, prime contractors, construction managers, design-build, etc.) all around the world. R.

eferences:Hyman, D. N. (1989) Economics. M cGraw Hill: IRWIN. Markgraf, B. H.

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http://www.smallbusiness.chron.com [Accessed on 1 December, 2016]. S upyan, V.B. (2003). E conomicaSShA. SP b.: Piter. Weisbrod G., Weisbrod B (1997) Measuring economic impacts of projects and programs. E.

conomic Development Research Group. Available from:

http://www.edrgroup.com.econ-impact0primer.pdf [Accessed on 3 December, 2016]. Williams, J. Political factors that affect development. Available at.

http://makewealthhistory.org [Accessed on 1 December, 2016]. Stephenson, H.L. (ed.) (2015) Total Cost Management Framework. An Integrated Approach to Portfolio, Program, and Project Management. Morgantown: AACE International.