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© Copyright 2002-2003. All rights reserved.
Page 36
How To Investigate Any Business Opportunity
Valuation Methods
There are two basic methods of determining the value of a business. The first is based on expectations
of future profits and return on investment. 
This method is preferable by far. It forces the buyer and seller to give at least minimum attention to such
factors as trends in sales and profits, capitalized value of the business, and expectancy of return on in-
vestment.
The second method is based on the appraised value of the assets at the time of negotiation. It assumes
that these assets will continue to be used in the business. 
This method gives little consideration to the future of the bushiness. It determines asset values only as
they relate to the present. It is the more commonly used, not because it is more reliable, but because it
is easier. The projections needed to value the bushiness on the basis of future profits are difficult to
make.
Looking Ahead
Whichever method is to be used to value the business, the buyer should ask the seller to prepare a pro-
forma, or projected, statement of income and profit or loss for at least the next 12 months. For this, the
seller will prepare a sales estimate for this period along with a matching estimate of the cost of goods
sold and operating expense.
The projected statement will reflect the net profit the seller believes possible. The buyer should then
make his own estimate of sales, cost of goods sold, operating expenses, and net profit for the next year
at least, and as far into the future as possible.
In preparing these statements, the buyer should start by analyzing the actual statements of profit and
loss for at least 5 years back. He should be sure that the past and projected statements provided by the
seller are correct and are consistent with the buyer's proposed future operation. He should also study
general and local economic changes that will affect future business. This includes competition.
If the buyer is not qualified to prepare projected financial statements, he should consult an independent
accountant. This will involve some expense, but the cost will be small compared to the loss he might in-
cur if he invested in a small business with a doubtful future.
Financial statements and their analysis and market analysis are discussed elsewhere in this section.
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