By Michael Luchies with the assistance of Kahuna Accounting’s CEO Frank Lunn and former CFO
Do you know your net worth? How about the value of your business?
If you’re like me, you haven’t kept active tabs on your net worth other than knowing that your student loan debt is higher than your combined personal and business checking account balances. I do, however, know it’s importance, and because of that, I’m changing how I approach my business and building wealth.
To learn more about net worth, the difference between it, and the value of an entrepreneur’s small business, I sat down with Kahuna Accounting CEO Frank Lunn and former CFO. Based on their experience and insight, here is what I learned about the differences between net worth and the value of your small business.
What’s Net Worth?
Your net worth is the most important indicator of your personal financial worth. In the most basic sense, your net worth can be broken down into the following formula:
Everything you own (assets) – Everything you owe (liabilities) = Net Worth
It’s hypothetically what you should receive in return for all of your assets, both tangible and intangible, after taking into account your liabilities, including what you owe creditors. As Kahuna Business Group CEO Frank Lunn put it, “The net worth of your business is the foundation and driver for personal net worth. Anything else is icing on the cake.”
What’s the Value of Your Small Business?
Your business has a different value to everyone. You’re going to value it much different than a bank, and different from an investor.
The standard approach to finding the value of a business is to take a multiple of the annual EBITDA (earnings before interest, taxes, depreciation and amortization). As a general rule, a multiple of 3-4 is considered reasonable for small and medium sized businesses. Example: EBITDA = $100,000; value (EBITDA X 3) = $300,000.
There are many factors to consider, so if trying to get an accurate estimate of what your business is worth, you need to first understand your goals. If you want to sell your business based on this value, you want the market value. If looking to bring on investors, that value could be calculated differently based on how they evaluate the worth of a company.
After knowing the purpose of the valuation, use standards in your industry to come up with a value that is in line with what an investor, banker, potential buyer, or other, considers to be appropriate.
What’s the Difference?
As an entrepreneur, your business is an asset, and it affects your net worth. But as you can tell by the description above, coming up with a specific value of that business can be extremely difficult.
This asset is non-liquid, meaning it’s not something you can instantly liquidate to get money out of. Because of this, most financial institutions ignore it if you’re applying for credit. If you are or will be in need of credit, your liquid assets become important and can help your business – meaning that your net worth benefits from the value of your business and can benefit your business if you have liquid assets that can be used as leverage.
You can’t separate your business from net worth, because it’s a component of that worth. Your overall net worth, however, does not directly impact your business’ value (even if you can use it to obtain credit), meaning you could be worth $10 million and have a business with little to no value due to a large amount of debt or lack of profit potential.
What To Do Now
Start with your goals.
What do you want to accomplish in the next 5, 10, 20 years? Are you getting ready to retire? Will you need a large sum of cash in the next year?
These goals and immediate needs will shape what information is valuable, what steps you need to take to accomplish your goals, and obviously, how you value your business.
If you’re trying to build long-term wealth, building a strong and valuable business is a great way to accomplish that. If you’re trying to retire in two years, you might want to start defrosting your non-liquid assets to make them a bit more fluid.
*A special thank you to Kahuna Business Group Founder and CEO Frank Lunn and Kahuna Accounting former CFO for contributing to this article.