Can we rely on business valuation calculators to estimate the value of a business? Are they just a good starting point or are they completely useless? In order to answer that question, we need to examine the complexity, input parameters and use of external data that comprise the online calculators that are available.
First let’s examine the complexity
Most online business valuation calculators are fairly simple to use and seem to be designed for small owner-operated businesses. They ask simple questions such as what the revenue of the firm is, what is the net profit and how much the owner takes as a salary. These simple online calculators fail to capture most of the important concepts that are important for valuing a business such as industry multiples, market position, brand recognition and not even any balance sheet items such as debt or assets. Other calculators, such as the ones that have the option to choose an industry, try to be more realistic. They also ask about future expectations of business performance and try to capture some balance sheet items such as cash and debt.
However, expectations of future business performance, according to a business owner who is looking to sell, can be often unrealistic or wishful thinking. The most sophisticated calculators go into profitability and risk metrics such customer concentration and market positioning, but they also fail to capture vital data. Basically, all business valuation calculators lack the complexity to capture even basic, purely quantitative valuation concepts that do not require much human judgment and could be used a starting point to consider further steps in buying or selling a business.
The input parameters used by most online calculators are simple, but others require the user to be quite proficient in business valuations or to have made complex projections about the future in order to enter any sensible information about the model. In most business valuation calculators, if the user is not prepared to input number backed by calculations and analysis, he or she would get a result that most likely has nothing to do with reality and is not even useful as a starting point. On the other hand, if the user has done the necessary calculations and analysis, he or she might as well finish the job themselves and produce their own approximate valuation that would be far closer to reality than any online calculator.
Input parameters and complexity aside, let’s examine what external data online business valuation calculators use, or at least what they disclose
Most business valuation calculators are not disclosing much in terms of data that they use to produce the final valuation numbers. Some disclose that they used data from a certain number of businesses but do not disclose how that data was collected or any information about the businesses whose data was collected. Other online business valuation calculators simply state that they use macroeconomic and industry data.
Online business valuation calculators are very good at disclosing their limitations and almost all claim they are good source for a “reality check” or a “starting point in the decision-making process”
However, after examining their choice of model inputs, complexity and external data use, business valuation calculators do not appear to be able to even fulfill that role. For a “reality check” purposes one can turn to their accountant, look at similar businesses for sale online or use comparable publicly traded companies.
In reality, business valuation calculators are used to drive traffic and generate leads for other services the provider might be selling. These include mostly business consulting services and financial services as well as selling your data to other businesses.
Our business lawyers in Miami, Florida USA recommend a potential buyer or seller to turn to a licensed valuation professional for a realistic estimate of the value of the business in question. Contact us to help you with your business valuation needs.
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