What's the business worth?
So it's good enough to continue with? But what's it worth? There are a number
of ways to value a business, some of which are explored below - your accountant
will assist with this.
What's it worth - You have started your evaluation process, you like what you
see and have enough information to make an offer (this is often subject to some
of the above checking out to be okay by your Accountant and Solicitor). There
are three components to the purchase price;
1) Plant - usually 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 is this business worth to me?"
Goodwill - 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 ROI 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, Johnnie's 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 and selling purposes. There are tools
that can be used to help, but at the end of the day it's what the business is
worth to you! In valuing a business always seek professional advice.
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 the nzbizbuysell website.
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