Rules of Thumb and Business Valuation

According to the dictionary a rule of thumb is a broadly accurate guide or principle, based on experience or practice rather than theory. According to Wikipedia it is a principle with broad application that is not intended to be strictly accurate or reliable for every situation.

In business valuation, rules of thumb are typically based on a specific part of the operations of a business, such as annual revenues or cash flow or some other easily calculated income-related metric.

Now look at your thumb and compare it to the thumbs of other people. You may see differences in the size, age, shape, color, strength, nail color and dexterity between you thumb and theirs. The are literally thousands of different types of thumbs.

Each industry, or type of business, usually has multiple valuation rules of thumb that could potentially be applied to it. This means there are literally thousands of different rules of thumb that are available to provide indications of value for different types of businesses. 

The differences between seller’s “thumb” and a potential buyer’s “thumb” can be quite significant, and generally speaking, no one knows what those differences will be until the two come together. So how can you use a simple rule of thumb to value your business or understand the value that a potential buyer might see in your business? While rules of thumb may be useful for some purposes. They can provide a whole range of potential values to your business. When it gets right down to it, most of the time a more specific, and supportable valuation is needed for the seller and the buyer to feel comfortable with the value of a business.

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