Are small business values based on earnings or revenues?
Updated: Sep 16
When valuing a small business, is it earnings or revenues that matter more? In essence, it's the earnings that take precedence.
To break it down, the worth of most small businesses is closely tied to their earnings rather than their revenues. In simpler terms, this refers to how much money an owner takes home from the business each year, often referred to as "owner’s benefit" or Seller’s Discretionary Earnings (SDE).
Let's delve deeper using an illustrative example:
Imagine two businesses that appear almost identical on the surface. One is located inside a mall, and the other stands freely just across the street. Both businesses report an annual gross revenue of $500,000. But here's where the difference lies: the business inside the mall shells out $10,000 each month for rent, while its counterpart across the street pays only $3,000 monthly.
So, what's the revelation? Despite identical revenues, the freestanding business has significantly lower overhead costs, enabling it to have higher earnings. When comparing the value of the two, it becomes evident that the business with the higher earnings (and therefore, the higher owner's benefit or SDE) would be worth more.
In conclusion, while revenues give an overview of a business's financial health, it's the earnings that play a more critical role in determining its true value. Always remember: it's not just about how much you make, but also about how much you keep.