A consulting business can be a profitable and enjoyable enterprise. As a business, a consulting firm can be valued but the valuation techniques used in most businesses are difficult to apply to a small consulting practice. The data used in the calculations can be quite uncertain and the premises for the calculations are often subject to change. Valuing a consulting business may be hard, but establishing an acceptable range is possible.
Determine the amount of the owner's discretionary earnings in the business. This figure is typically the owner's salary, profit, and benefits added together. This amount is often quite close to the firm's EBITDA (earnings before interest, taxes, depreciation, and amortization).
It is common in the valuation industry to use owner's discretionary earnings to value a business. Other measures of value such as book valuation or industry comparable valuation are more useful in businesses--such as manufacturers--with hard assets. A consulting business has few assets, so its value today is a multiple of its earnings.
Determine the earnings multiple the consulting business is worth. Every business can be valued as a multiple of its earnings. This multiple typically ranges from 0.25 to 3.5. This figure is essentially the number of times a buyer is willing to pay the annual owner's discretionary cash flow to acquire that income stream.
The trick in valuing a consulting business is that the annual cash flow in a small firm is dependent on the work of a few individuals. If those individuals cease to bring in new business, the firm is worth much less. If the buyer expects the income to stay the same after the purchase, then the value of the business will reflect that.
Multiply your chosen earnings multiple by the owner's annual discretionary cash flow to arrive at the firm's value. Industry consensus seems to be around 0.75 to 1.25 for an earnings multiple in a smaller consulting business.
Solo consulting firms are essentially worth the book value of the firm and little more as all of the cash flow is generated by the one consultant and that cash flow will cease coming into the business once that consultant sells the firm to another person.
The "value" of anything in a free market is only what a buyer is willing to pay.
Kelcey Lehrich has been writing for several online media outlets for the past few years. His work can be found on Electronista.com, Macnn.com and LeftLaneNews.com. Lehrich holds a bachelor's degree from Cleveland State University in business administration and finance.