Does Net Present Value Apply to Home Businesses?
Does Net Present Value Apply to Home Businesses
?When you want to stop your Home Business the worst thing to do is to stop suddenly or slowly with the thing that has made your Home Business so successful. Why? Think of all the hard work that you have put into building your business into a success. It is probably still going strong and generating a lot of income for you. Why not try and sell your business because it is obvious that it has some sort of value?
Before selling anything you need to assess your company and calculate the possible value of your Home Business. In that way you are able to defend and justify the price you are asking. Important to note is that value is subjective and not the same as price. The question is how to value a company. There are several methods to value, but one of the better methods is the net present value of future cash flows, abbreviated as NPV 1).
The NPV takes into consideration three variables. First of all, value is being calculated with the forecasted cash flows (and not profits). You need to think very carefully how much cash your Home Business will generate in the next years. These assumptions are based as well on historical performances as on future trends. Why cash and not profit? Cash pays your bills and food. Profit doesnt do anything for you. It is a term that is used for all kind of (accounting) purposes, but it is influenced by many factors. Due to that you might even see an increase in profit but a decrease in money you have left in your pocket.
Second of all, the NPV method wants to know when that cash will be generated. It is important to know if you get US$ 100,- now or in 5 years. Most people will prefer to have it now, also because in 5 years that money cannot buy them the same things because its value changes in time. But even more important is that when you have US$ 100,- now you can decide to invest it in order for it to increase.
Third of all, any buyer wants to know what the risk is of his investment, which is shown in the rate of return. Your Home Business is not risk free. The higher the risk the less people want to pay for it.
Even though the formula seems easy enough, calculating a company value is not as straightforward as it involves a lot of estimating and knowledge of the market. And as it is not an objective measure everybody will end up with a different outcome. Even better than calculating a single value you should actually calculate a band width. And as mentioned before, you need to know how you value your Home Business in order to negotiate a good and fair price.
1) NPV = cashflow at time 0 + (future cashflows /[ 1 + rate of return])
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