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Part of Why does a valuation calculator's multiple describe a deal instead of pricing one?
Rules for using a valuation calculator without letting it decide the price
This page computes nothing. Rules for using one that does: what a tool must show, where inputs must come from, what the output may do, and when none may be used.
This page computes nothing. It gives the rules that make any valuation calculator you use safe. A tool must meet its own conditions before its output means anything.
Your inputs have rules. So does what you may do with the output. Where an authority over the figure has set its own requirements, no calculator may be used at all.
None of the rules is a law. They are the disciplines that stop a rough orientation from becoming a costly belief.
What to take away
- A calculator's output is only as meaningful as the ratio behind it and the records behind your inputs. The rules below protect both ends.
- The output may orient you. It may not price the business, judge an offer, or leave your own file.
- Where a figure is for tax, an estate, a dispute or a lender, the requirements are set by that body and by a qualified appraiser, and a sale of this size warrants an intermediary, an accountant and a lawyer who will tell you which requirements apply.
Rules the tool must meet
A calculator earns the right to be used at all only if it satisfies all five. If it fails any one, close it.
Calculator must-pass rules
- Shows the ratio it applied
- Names data source and period
- States which earnings definition it expects
- Says what it cannot see
- Tells you who operates it
It states the source and date of its ratio. The tool names the data behind the multiple it applies — a transaction database, a published study, or a stated series — and the period that data covers. A multiple with no stated source cannot be judged, and a multiple drawn from another industry or another size band is not evidence about this business.
It defines every input it asks for. The form says whether the earnings figure it wants is before or after owner compensation, whether it wants one year or an average, and what date the figure is stated as of. A tool that asks only for "profit" cannot be answered correctly, because it has not told you which profit it means.
It shows the arithmetic. You can see the figure you entered, the multiple applied and the result, and you can reproduce the calculation by hand. A tool whose answer moves with no visible step is the hidden ratio these rules exist to expose.
It reports a range and names the basis of value. The output is a spread, not one figure, and the tool says whether it is imitating fair market value, fair value or something else. A tool that ignores the date of the figure and the purpose behind it is not performing a valuation.
It declines to price the business. The output itself says the figure is a screening indication and that a defensible value requires a qualified person working from records. A tool that answers with one dollar amount presented as the value of the business has failed this rule before you typed anything.
The calculators guide explains the mechanism these rules are protecting against: an input scaled by a hidden ratio. Concretely, the ratio is a multiple — the price of a comparable business divided by one of its earnings measures — and the tool applies that multiple to whatever figure you type in. The rules exist to make the multiple, its source and its date visible enough to judge.
Rules for your inputs
Inputs come from records, not from memory. The earnings figure you enter should be one your accountant has produced from the accounts, with adjustments documented. In the United States, the IRS's page on recordkeeping describes what records a business is expected to keep; those records, reconciled, are the only legitimate source of a calculator's inputs. A figure entered from recollection produces an output that inherits the recollection.
Input rules
- Inputs come from records, not memory
- Inputs match the tool's definition
- Use most recent normal period, not best
- Choose category as a buyer would
Inputs match the tool's definition. If the tool expects the operating result and you enter the owner's total benefit, the output is wrong by roughly your own labor. If the tool does not say which it expects, the tool rules above already told you to close it.
Inputs are the most recent normal period, not the best one. An unusually good year entered as the base produces an output that describes the unusual year. Enter what the business ordinarily does, and note separately what was unusual.
Category is chosen as a buyer would choose it. Where two dropdown options fit, the buyer will pick the one that produces the lower figure. So should you.
Rules for the output
The output is a region, not a point. It says the business is in a neighborhood. It does not say where in the neighborhood, because where depends on everything the form did not ask.
Output rules
- Output is a region, not a point
- Not a present value of anything
- Sets no price, judges no offer
- Stays in your file
- Discarded once a real figure exists
The output is not a present value of anything in particular. A real valuation discounts a forecast of future cash at a rate that expresses its risk; that is what net present value means. A calculator's ratio is an average of other businesses' outcomes, and applying it to your input does not perform that calculation. It imitates its shape.
The output sets no price and judges no offer. An asking price comes from the accountant's range and the intermediary's transaction data. An offer is judged against that range and against its structure, since the same headline can be mostly cash or mostly promise.
The output stays in your file. It is not shown to a buyer, a seller, a lender or an intermediary as evidence of anything. What crosses the table is the earnings basis, the adjustments and the record behind them.
The output is discarded once a real figure exists. After the accountant has built a range from the record, the calculator's number has no further role, and remembering it only anchors you to a figure nobody can defend.
Where no calculator may be used
Some figures are governed by a body with its own rules for producing them. A valuation for a tax matter, an estate, a dispute between partners or spouses, or a lender's decision uses a basis of value set by that body.
For a federal tax figure on a closely held business in the United States, the standard is IRS Revenue Ruling 59-60, and an estate figure is reported on Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return, with the gross estate valued under Internal Revenue Code section 2031. Work prepared for courts, lenders and estates is expected to follow the Uniform Standards of Professional Appraisal Practice. The person who signs such a figure normally holds a business valuation credential — ASA, CVA, ABV or CPA/ABV — and it is that signature, not the software, that carries the liability.
When no calculator may be used
Is the figure for tax, estate, dispute or lender?
Qualified person, stated date, set basis
Calculator may assist, never decide
It is prepared as of a stated date by a person qualified to sign it and liable for it.
No online tool meets that requirement, and using one is not a shortcut because the body will reject the figure.
Which basis applies, and who may produce the figure, is a question for your accountant, and for a lawyer where a court is involved. The valuation methods guide explains why the purpose of a valuation legitimately changes the answer.
The same applies, less formally, to the figure on which a sale is actually negotiated. The buyer's diligence will build its own from your record. The seller's range should be built the same way, in advance, so the negotiation is between two figures built from evidence rather than one from evidence and one from a form.
A one-line test
Before you act on any calculator output, ask: could I explain to a buyer's accountant where this number came from? If the honest answer is a menu choice and a hidden ratio, the number is not ready to leave the page it appeared on.
