Can I value a business based on its profit?

Profit is a sound place to start. BDC says business valuation often begins with assessing operating earnings using financial performance measures. The catch is that the profit on your income statement is not automatically the figure a valuation uses. Which profit you use, and what you adjust, can change the answer, so it helps to know the terms.

EBITDA is not the bottom line

BDC calls a multiple of EBITDA the most common method used to determine a fair sale price for a business. EBITDA stands for earnings before interest, taxes, depreciation and amortization, and BDC describes it as a measure of a company’s ability to generate operating earnings. It is not the bottom line. BDC explains that net income, also called net profit or earnings after tax, is the money left after all expenses and taxes are deducted from all revenues and gains.

Normalizing the number

BDC lists failing to normalize earnings as a valuation mistake. Normalizing means adjusting for special factors, such as discretionary and non-recurring items, and non-market-rate revenues and expenses. An owner’s personal costs run through the company, or a one-time gain, would be examples to raise with your accountant. Be ready to support each adjustment with records.

Profit is not the only check

After arriving at the EBITDA-based figure, BDC says a professional business valuator typically seeks to confirm it using other approaches: the value of the tangible and intangible assets, and what comparable businesses sold for. Valuing on profit alone therefore gives you a starting estimate rather than a final price. For a related warning, read pricing from a friend’s sale.