Business Planning:

Fair Market Value of Your Business

To determine the worth of your business, fair market value, you have to deploy a couple of methods. They are the revenue method or income method and the property method or asset method. Usually, it is time to assess the worth of your business when you are either selling a business or asset held by you or are in the market for one. Another approach that always works is researching the business you are interested in buying or selling it to. Sometimes your worth is increased if you properly investigate the business you are selling to. Maybe the business will benefit more than you expected by acquiring you. You could be a major competitor and by eliminating you, the business can triple their profits.

• The revenue method is simple. The amount of money your business generates minus the expenses is usually your profits. The profits are used here to determine the fair market value of your business. This is how it works. You take the after tax profits or gains (the tax depends on which tax bracket you are in depending on your income level and also how profitable your business was in a tax year) and you divide it by the capitalization rate. This is a conversion method that determines the value of the business from the income. The cap rate is set by the federal reserve. The formula is simple:
  
  After-tax profits / cap rate = fair market value
  Ex. $20,000 / 10% = $200,000
• The property method exists for one reason, which is if the revenue method generates fewer profits than the value of the property or assets being sold with a business. For example you own a small film company. The movies you have made over the years have not made much profit. Last year, the movie you made went to video and made about a million dollars there. You didn’t see much of it, only about fifty percent of it. Taking out the cost of production and taxes, you are left with about $80,000 in profits. The equipment in your company is worth $400,000. The fair market value of your business using the cap rate of 25% is $320,000. That means if you sold your business using the revenue method, you are actually losing about $80,000. But by using the property method, and combining with it the goodwill figure used by many business to show the value of their name in the business and consumer patronage, we arrive at the following:
  
  $400,000 - $320,000 = $80,000 (goodwill figure)

This figure is obtained by subtracting the equipment cost with the fair market value.

$80,000 + $320,000 = $400,000
By adding the goodwill figure and fair market value, we arrive at the true worth of this business. Use this method only when the profits outweigh your investment in the equipment or property.