When you are trying to create cash-producing assets, you can either choose to build one from the ground up yourself or to simply purchase an asset from another person. There are a whole host of things to consider when deciding whether or not to invest in a particular business. In this article, we will focus on how to determine the value of a business; in other words: how much should you be willing to pay for any given business?
1) The first step is to determine the assets held by the business that, as the new owner, you would inherit. Along with tangible assets like a building structure, furniture, equipment, and inventory, be sure to include intangible assets like copyrights and brand recognition. For example, if everyone knows that Antonio’s has the best pizza in town, then upon purchasing that restaurant you aren’t just purchasing the ovens and the location; you are purchasing the brand recognition that comes with the “Antonio’s” name.
2) Then, ask to see the books. If the current owner doesn’t keep good records, this should be a warning sign. After all, without accurate records, how can they tell you whether or not the business is truly profitable? Try to get as much information as you can about the operating costs and sales of the company. Are they pretty standard from year to year? Are sales and costs going up or down?
3) Then, try and make some projections for the future. How much money can you reasonably expect the business to make during the next five or ten years? Be realistic, and remember that unpredictable events (like economic downturns, new competition, changes in costs, etc.) may adversely affect your predictions. Try and determine how much time will pass until you will have made back your investment and make sure that you are okay with it.
4) Finally, take into account reasonable predictions of inflation to have a realistic idea of what kind of buying power the business will be putting into your pocket. A $10,000 yearly profit might not be so impressive twenty years from now.
Purchasing a business can be a scary ordeal, but by doing your homework beforehand you can minimize the risk and make sure that the asset produces cash for the foreseeable future.