Business Valuation as it relates to Business Sale Price Calculation and Working Capital

Business Valuation as it relates to Business Sale Price Calculation and Working Capital

Business Valuation as it relates to Business Sale Price Calculation and Working Capital

General definition. Current assets – current liabilities = Net Working Capital

In most cases the valuation of a business does not include the net working capital of the business at the time of the valuation. Working capital is often excluded from valuations so that business values can be compared to other similar businesses without the need to adjust for working capital. If 2 businesses are identical except one has $1,000,000 in excess cash it won’t affect the valuation comparison because the excess cash is not in the valuation price for the businesses.

However, the working capital can affect the actual selling price of a particular business if the working capital is included in the sale.


Let’s say Business A is valued at $5,000,000 and business B is valued at $5,000,000, both without working capital. If business A has $700,000 in net working capital and business B has $1,500,000 in net working capital, and the buyer wants to buy the working capital with the business, then business A will sell for $5,700,000 and business B will sell for $6,500,000 even though both were valued at $5,000,000.

Many buyers want to buy a business with adequate or normal working capital. By doing this the buyer has a set amount of capital to raise that allows them to purchase the business. This capital to buy the businesses is likely long term capital. By including working capital in the purchase, after the sale, the business can operate on the purchased working capital.

The larger the transaction the more likely that working capital will be included in the business sale. The working capital target number (i.e., the amount specified in the LOI to be included in the purchase price) is an important negotiated element of a deal. In the LOI it might be a dollar amount or often an agreed to formula (since the working capital moves virtually every day the business is open) to use to get to a working capital number at closing. Make sure all elements of the working capital calculation is defined and understood.

Common Working Capital Elements

(with notes on the tricky ones);


  • Cash and cash equivalents
  • Accounts receivables
  • Inventory
  • Deposits – Deposits business has at vendors or other i.e., tax deposits, lease deposits, etc)
  • Work-in-Progress – Does your accounting system account for this properly? WIP can also be a liability depending on billing practices.


  • Accounts payable
  • Accrued payroll
  • Vacation owed employees
  • Gift certificates Does your accounting system track?
  • Warrantys Outstanding for products or services
  • Prepaid service or maintenance agreements
  • Deposits from customers
Best Basic Accounting Book for Small Business Owners and Buyers

Best Basic Accounting Book for Small Business Owners and Buyers

I found this basic accounting guide and it’s the best I’ve seen at presenting basic small business accounting in an easy to follow manner.

This book is under 100 pages and under $10…if you’re a small business owner this could be the best $10 you ever spent.


Accounting Made Simple – Understanding Accounting Principles in Less Than 100 Pages

If you are considering buying a business or you own a small business and hope to sell it one day take the time to review this book and implement the simple solutions that will make your business more valuable.

When buying a business it’s important to understand accounting principles so that you can condut the proper due diligence. This book will help simplify the process and also help you prepare your financing when seeking a bank loan or support from investors.

So you’re in do you get out?

I was meeting with a business owner the other day and he said to me “When I started this business I never gave any thought to how I would get out of it, never crossed my mind.”

His business now does over $3 million in sales and has significant value….but no where near the value he thinks it has…….for one reason.

He’s never looked at his business the way a buyer for the business would look at it.
In my line of work, I see this nearly everyday. Business owners don’t understand, or at least they don’t have an appreciation for, the difference between a good business for them and a business that would be valuable to someone else. Understand how to value a business from the eyes of a buyer is an important part of the business owners job.
A perfect example was the business owners (let’s call him John) strategy as it relates to the real estate the business utilizes.
John started the business 10 years ago, it grew quickly and started generating good profits. About 6 years ago John decided he needed a new, bigger, building for his growing business. John also decided he wanted exposure on a major freeway so everyone would be able to see his business.
John located a great building with an excellent location. He went to his bank who was willing to give him a commercial real estate loan to buy the building because the business had the cash flow to pay the note. Everything was great. He moved into his new, bigger business and life was good.
However, John was only focused on making the note payments on the building. As he said to me “the business paying down the debt on the building is my retirement fund.”
Now fast forward to today.
John’s business is generating a profit for himself of $10,000 per month or $120,000 per year. Pretty good, wouldn’t you say?  Maybe……maybe not.
The area around John’s business has grown and property values have increased while Johns note has stayed the same. Good right? Not necessarily.
John’s note is $8,000 per month which the biz can afford…BUT  the real estate is now worth much more than he paid for it. If John were to lease the property out at today’s fair market value he could lease the building for $15,000 per month.
But remember John’s biz profit is $10,000 per month. If John was getting fair value for the property he would get $15,000 per month which is $7,000 per month more than the $8,000 monthly note payment.
If we adjust John’s monthly expenses to reflect fair value for the building then John’s monthly profit drops from $10,000 per month down to $3,000 per month ($10k – $7k).
John is now stuck.  His business can’t afford a fair rent but he needs the building to run his business. John’s real estate value makes his business value very low. A buyer who pays fair value for the real estate won’t have enough cash flow from the business to pay the note and a reasonable salary for himself.
John came to me thinking he was in a great situation and left thinking his situation was not nearly as good as he thought.
Do you have a business that one day will need to be sold? What concerns do you have as you look ahead to that day?


Using Credit Cards for your Small Business Financing

I see many, many small businesses that use the business owners’ personal credit cards to finance their business. Although this is often an easy source of cash it can be a terrible way to manage and grow your small business.

Often the biggest issue we see is that the business owner doesn’t understand the relationship between the interest expense on the credit card debt as it relates to the net profits the business generates. We regularly see businesses where they are guaranteed to lose money on the sale of an item which the business owner set the price. Meaning the business owner thought he had priced the product to make a profit but in fact the price guaranteed a loss.

Here are some problems you might want to try to avoid. Here’s an example of what we see.

John owns a small sign business let’s call it SignCo. John started the business in his garage a few years ago and now he’s opened a shop in a small retail center. When John started the business he was a sole proprietor but last year he formed an LLC when he moved into his retail space. To get the retail space looking good John needed to buy some shelving, signs, cash register, chairs, etc. SignCo is too new and a bank won’t give the business a loan but John has personal credit cards and he puts his purchases on those cards. John has total of $20,000 on his credit cards and his interest rate is 18%.

John put together a budget for SignCo and he wants a 10% profit after operating expenses.

SignCo’s average sale is $100. How much does SignCo need to sell each month just to pay the interest on John’s credit card debts?

The answer $3,000 per month or 30 signs per month just to pay the interest on John’s credit cards. That’s $36,000 per year or 360 signs to pay the interest. It will take the sale of another $200,000 to pay the principal!

The math: $20,000 x 18% = $3,600/yer interest divided by 12 months = $300 per month @$10 profit per sign that’s 30 signs per month just to pay the interest.

The point is you need to understand the relationship between your profits and your debt costs before you make a decision to borrow money from anyone, including yourself.

Here are associated articles “How to Start a Business like you’ve Done it Before”  and Business Owners and the Personal Guarantee

Finally, too many small business owners also fail to realize that personal credit card interest may not be tax deductible without some tricky accounting and documentation. If a business owner is running up his personal credit cards and then paying them off from his income from the business he is likely losing a substantial tax deduction, assuming he’s actually making a profit.

A very helpful book on managing small business finances:

Another article you may find useful:
Understanding the Inventory to Cash Cycle in Your Small Business

Build a Business that Can be Sold –  What makes a business valuable to a buyer?

Article Library – Buying , Selling and Running a Business

Can Owning a Small Business Make You Wealthy?

What’s the Value of This Business? Here’s a little game, takes 2 minutes

Options for Small Business Accounting

Over the years I have tried a variety of small business accounting solutions.  A huge leap forward for small businesses is the cloud based small business accounting software. Based on my experience a small business’ best option is a “cloud” based solution. A cloud based small business accounting package has some significant advantages and a few disadvantages.


  • Your software is always the current version
  • You can allow direct access to your outside CPA. This may be the best feature since it allows you to very efficiently book the entries that I used to wait til the end of the month (or quarter, or year, or when the taxes get done). Now when we have something odd to book we simply call the CPA, we login together and the CPA shows us the proper booking, What used to go on someone’s “to-do” list is now done correctly the first time.
  • You can access your bookkeeping and accounting records from anywhere. Small business owners often complain about being tied down in their chair at the office but you don’t need to be.
  • You can outsource many activities which a remote user can do part time and at a lower cost because they can access your accounting system. This could save you hiring a full time person or trying to train people to do complex jobs part-time.
  • There’s a monthly subscription fee depending on the level of service you choose.
  • Getting your CPA to use something other than Quick Books might be a challenge. But remember, you have to use the system everyday. If you find a system that works better for you than Quick Books have a discussion with your CPA about the benefits to you.
Although Quick Books is the most widely used and certainly a safe choice, I find the Quick Books “on-line” version to be slow and cumbersome. 

There is also the option of outsourcing virtually all of your bookkeeping to a company.  If you want to see what services an outsourced bookkeeping company provides go to GrowthForce they are experts at outsourcing small business accounting services.

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