What It’s Worth – Valuing Your Business.
By Richard O'Brien
You have decided to sell your business, but what’s it worth? This
is a good time to talk to a Business Broker – (see our New Zealand Business Brokers Directory)
and/or your Accountant and a Valuer. There are three key components
to setting the price;
1) Plant – usually priced as a going concern (but not always),
with it’s value derived by a registered valuer (both parties can use their own
independently – but usually agreeing on one is fine). These are the tangible
things required to run the business.
2) Stock – SAV means stock at valuation (at cost), this is the
norm, however obsolete stock may be devalued.
3) Goodwill – the subjective and intangible stuff, some call
it an art, others a science…it’s a mix, using some tools to assist with the
process. The final question is “What will the market pay?”
Plant and Stock – these are relatively straightforward.
Goodwill – this is more subjective. The following offers a
quick overview on some of the more common goodwill valuation tools in use:
(Note: some businesses will have little or no goodwill, and some derive a value
from using 2 or 3 of the following methods.)
• Sales statistics and Industry rules of thumb.
Often common with small business valuations is the use of
industry rules of thumb. While this approach lacks investment analysis, it can
be useful when used in conjunction with other methods. It relies on deriving an
average value and formula from a number of similar types of business sales and
tends to be used more as an indicator. It looks at a historical average, and
may vary somewhat from what you are looking at. Business brokers, valuers and
accountants have the best information on industry indicators.
• Return on investment - ROI (Valuing the Profits)
This is the most common method and is sometimes referred to as
the Capitalised Earnings method (It is used particularly with higher value
businesses).The easiest way to explain this is to look at a simple example:
Johnnie’s Pushbikes produced an adjusted net profit (and
before owners salary) of $120,000 (EBIT). The net assets
(Valuation of plant and stock) for the business were $140,000
and a fair salary for Johnnie (owner) is $50,000.
If someone was looking to invest in this business they could expect a 30%
ROI, as this bike shop offers a low to medium-risk investment
opportunity. (Most small businesses require a return of 20% for low risk
opportunities to maybe 50+% for a high-risk venture).
To calculate the ROI if one was to buy Johnnie’s business:
Net
assets
$140,000
Goodwill
asked $75,000
Business asking price $215,000
Return on Investment
Desired return (given risk) $30%
Say purchase price is $215,000
Required
Return
$64,500
Business profits (EBIT) $120,000
Minus Owners salary $50,000
Profit
$70,000
In this example, Johnnies business meets the return on investment. At 30%, your
$215,000 would return $64,500/annum – this business does slightly better at
$70,000.
• Earnings Based Method
This method is similar to the ROI or Capitalisation method described
above. The difference is that it splits off return on assets from other earning
(the excess earnings). Not widely used.
• Cash Flow Method
Buyer’s sometimes look at a business and evaluate it by determining how much of
a loan its future net profits will support. They will look at the net profit
(EBIT) before owner’s drawings and depreciation, and will subtract from this an
estimated annual amount for replacement equipment and a fair salary acceptable
to the new owner. This adjusted net profit is used as a benchmark to measure
the firm's ability to service debt. If the adjusted cashflow is say $100,000
and borrowing interest rates 10%, then for the buyer to amortize the loan over
5 years, the maximum a buyer is willing to pay for the firm would be about
$253,000. This is the loan payment that $100,000 would support over 5 years.
Or possibly the Discounted Cash Flow Method - This approach is
based on the principle that: “the value of the business is equal to its future
cashflows discounted to net present values at a rate which reflects the risk in
the business”. It is more appropriate where there is little history – it relies
on; a 3-5 year forecast of earnings, cashflow forecasts, what the super profits
are, and discounting these back to today’s value. It’s a good idea to use your
accountant or financial advisor.
• Realisation of assets
In some instances, a business is worth no more than the value of its tangible
assets. This isn’t always the case even if a business is losing money. Selling
such a business is often a matter of getting the best possible price for the
equipment, inventory, and other assets of the business. The assets value can
range from where they are priced as a Going Concern. ie. Assets are valued as a
working part of the business, or at Salvage Value (the lesser) where assets are
only worth what they would fetch individually if dismantled and sold.
There is no set way to value a business for buying or selling purposes. There
are tools that can be used to help, but at the end of the day it’s what someone
is prepared to pay for the business. It’s important to be realistic and to seek
professional advice on this.
Richard O'Brien is the Managing Director of nzbizbuysell - an online
advertising site dedicated to the buying and selling of New Zealand businesses.
For further details, visit nzbizbuysell
Alternatively to request an advertising information pack, please click
HERE
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