Sue is a buyer of a business for sale. She is looking at two businesses making stuffed ponies, and wants to know which one to buy. How does Sue choose?
Sales of both companies are $1MM. The cost of goods (COG) for both companies is 25%, with the same definition of expense items within COG. The age of the equipment is the same. One company is making $100,000 cash to owner and the other $80,000. Evaluation of both sets of books suggests no fancy bookkeeping by either. The companies are in the same town and thus there is no personal reason to choose one over the other.
Why would Sue pay the same for the company making $80,000 as she would for the company making $100,000?
The suggestion that one should pay a percent of sales based on some rule of thumb just does not make sense. Either the buyer or seller could be harmed in trusting such a method. The efficiencies or not of the business-for-sale operation in recent years should be the major driver of such valuations.
Buy the stuffed ponies with the most money for the owner!