Many business are valued by the application of Rule of Thumb Method to various figures or measures.
The Rule of Thumb method has advantages including ease of application, acceptance by the market and because they are quick and easy. It is possible for mental calculations of worth to be made – a most useful advantage especially during often lively discussions at the negotiating table. However, because of their simplicity of application and almost total limitation to gross income figures, rules of thumb have some disadvantages and these include:
- An assumption that gross income reflects the most economic use of all the business other assets like plant and equipment and furniture and fittings.
- Without adjustment of existing and past income for future variations in the business the method can ignore business potential.
- Difference is ignored in operating financial and management costs and expertise.
- Movements in business cycles or broader economic factors are ignored.
- No distinction is drawn between two businesses of different sizes. The sheer size of a particular business may limit the number of participants in the market who can raise the necessary cash.
Recognising that Rules of Thumb are accepted in the market place for the reasons given here, I believe that a combination of methods should be used.