I get the feeling this is a book promotion, but I like the question and it is asked much on the forums and never questioned. And it isn't about which is right - they all have basis. And most that use them, use a weighted average for their own calculation - just as in a house appraisal.
The first question that needs asking is what price:
* the one a market has prescribed through rational AND irrational trading?
* the true value of the cash flows given all the known risks.
Are two businesses that gross $100K and profit $50K worth the same thing?
* What if one is rising and the other is declining?
* What if one has $50K in assets and the other has none?
* What if one requires $100K to grow 10% and the other requires little if any to grow that 50%?
* What if one will finance 75% and the other finances none?
The methods discussed here are loose "rules of thumb" that take income/profit and derive some value based on some multiple of sales/profit based on cash valuations, markets, etc. Sometimes the MULTIPLIER is derived from a market approach. Sometimes the multiplier includes inventory - others not.
As in most markets, if this is what everyone is saying, it is what the majority will do. Just as in the stock market when one guru says something the multitudes that don't understand buy on his advice, whether he understood or not. Whether he was just profiteering or not. So, just because it is what most are doing, doesn't mean it is good for you to follow.
The fact is, there is a REAL value for the cash flows - given the major risks/risk aversion of the company and industry. But if you don't understand that process, there are "rules of thumb" - like measuring an inch with your thumb. It works - depending on the accuracy you require - depending on your understanding of measuring. (smile)
I submit the BEST PRICE is having the REAL value for cash flows and buying those the market irrationally underprices at even more undervalued prices! (smile)
If you go here you can read a great article about the evaluation of small businesses for the purpose of buying or selling them.
Take a look then tell me, have you used any of the three methods discribed for buying or selling yourself?
Which do you feel is the most accurate?
I look forward to heaing what you have to say!