Valuing a business you'd like to acquire

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(FORTUNE Small Business) -- Dear FSB: I am looking at buying a European tour business based in New York. Can you please suggest the best way to evaluate the selling price? The business is only two years old, but it has good margins and almost $900,000 in sales.

- Diego Sanchez, New York City

Dear Diego: The value of any business is ultimately based upon the economic benefit it is expected to generate for the owner - and its associated risks.

The best way to measure that benefit for a services company is to examine the business' cash flow or expected income, says William Quackenbush of the New York City-based Advent Valuation Advisors.

"You should be buying profits, not a job," Quackenbush says.

Start by gathering the information in the company financial statements. Then, to get a selling price, find the right valuation multiple. That multiplier generally falls between 1x and 4x, depending on whether you use pre- or post-tax cash flows, says Mark Gottlieb of MSG Accountants, Consultants and Business Valuators, which has offices in New York City and Connecticut. For example, if the multiple you select is three times post-tax cash flows, and the business has a $100,000 cash flow to the owner, an appropriate selling price might fall around the $300,000 mark.

Specific microeconomic and macroeconomic factors affecting your industry will help decide the multiple. Gottlieb, who does evaluations for the travel industry, points out that the dollar's value has fallen to historical lows against the euro, so you should look at how well the business is shielded from any impending drop-offs in the number of American travelers heading to Europe.

To help gauge this risk, look to why customers are using this particular tour company. Is it because of stellar service, or exclusive contracts with partner operators in Europe? That might hold the business in better stead than if low prices are its primary driver, Quackenbush says.

A quick way to select a good ballpark multiplier is the "market method": compare the business you're looking at with ones recently sold.

A search of private transactions for tour companies over the last few years yielded a handful of comparisons, Quackenbush says.

He found that small tour operators have sold from anywhere between 0.28% and 0.52% of their revenues - or, taking another benchmark, between four and five times EBITDA (earnings before interest, taxes, depreciation and amortization).

But remember that the multiplier method doesn't always account for the intangibles that make a business what it is, says Rick Shaffer, a Aurora, Ill.-based business broker.

"A touring company is so unique and the buyer pool so small that it would take a professional business valuator to do it justice," Shaffer says.

Gottlieb adds that "valuation as a process is as much an art as it is a science."

Another measure to keep in mind, says Quackenbush, is that the selling price should not be greater than the cost to create the business yourself, from scratch.

Either way, the experts suggest you consult with a broker or an investment bank to help evaluate your next steps.