Liquor License: Valuation of a business
IntroductionASales Value...: Valuation of a business Introduction A Sales Value is the Value that a willing and able buyer is prepared to pay for a business, w...
Wednesday, 23 April 2014
Valuation of a business
Introduction
A
Sales Value is the Value that a willing and able buyer is prepared to pay for a
business, with a given Net profit at
a given time, taking into account micro and makro factors which have an
influence on that business at that given time.
At
the end of the day it is market forces that have the last say and the sales
value of a business is determined by the Net profit with micro and makro factors adjusting the final calculation.
Ask
twenty “experts “to calculate the sales value of a small business and you will
receive twenty answers. The value of a business is often nothing more than a
perception. The buyer, the seller, the accountant and the short term insurer
all have their own values. It is interesting to see the difference in the Value
of a Business between the calculations of the accountant of the seller and the
accountant of the buyer.
Misconceptions. (a view or opinion that is incorrect because it is based on faulty
thinking or understanding.)
1
Multipliers
The
desired price was calculated at three or four times the monthly sales. This
method was particularly common in the food industry, such as
Supermarkets and Restaurants.
The
value of Fuel Stations was calculated at Rand per liter sales.
This
method of calculating is defective in that the monthly sales can not determine
the value of a business. You can have several businesses with the same sales
per month, but each have a different Net profit. (the overheads, markup and
stock holding all has an influence on the Net profit). Some businesses are open
seven day a week; others are open only five days per week. Some businesses are
in a very high security risk area others are in a shopping mall. Some
businesses are vulnerable to influences such as change in Government
legislation, weather or public perception.
The main factor is the Net
profit and not the sales or turnover that is used to calculate the Market Value
of the Business.
2
Asset value plus goodwill.
A
business can have an upmarket image with state of the art assets, but it is
running at a loss or is making a very small profit. If there is no or very
little profit in relation to the asset value, why would anyone invest money in
the business if the investor does not receive an acceptable return on his investment?
You can attempt to determine the value of the assets and buy the assets, but as
a business it has no value or little value. Further the value of the Goodwill
is difficult to determine.
Does Goodwill exist?
Some
financial institutions dispute the existence of Goodwill. Let us say you open a
fast food restaurant called Rommel fast food, and you are next to a well known
Franchise restaurant. Rommel has operated for three months, but the well known
Franchise restaurant, which is distributed throughout South Africa and has been
trading successfully for twenty years. Then surely the Franchise restaurant has
built up a notable Goodwill compared to Rommel.
To
start a liquor store, you need to apply for a Liquor License. You can pay rent
on an empty shop for say six months before you receive your Liquor License.
Then only can you fit the shop with fittings and stock the business.
If
you start a new business, you never know how long the business will take to
reach Break Even point. (this is when the Business does not make a profit or a
loss). Say the Business takes two months to reach Break even point, then you
had eight months “loss” before you start making a profit.
Now
once your Business is running at a profit and you want to sell the business,
the above factors must be brought into the equation. It is true that the buyer
can not pay for your mistakes or set up cost. Therefore a newly established
business with a small profit can hardly be sold at the set up cost. It is just
too high.
Therefore
a well established and profitable business does have Goodwill through its name,
products, services, customer relations and customer loyalty.
There
are exceptions. If you buy a Hairdressing Salon the customers or Goodwill can
be attached to the Hairdresser. Therefore, if the Hairdresser leaves very
little or no Goodwill remains with the Business.
The
following factors influence the value of a Business. :
- Type
of business
- Asset
Value
- Trading
Hours
- Lease
conditions of the site
- Manager
or self-management
- Debtors
and creditors
- Stockholding
- Method
of payment for the business
- How
long has the business been trading
- How
long did the seller have the business?
- Micro
and Macro factors
- Labour
- Bee
laws.
- Location
- Security
- Contracts
Let's
evaluate each one individually.
- Type
of business
During
the last few years, well known successful franchise businesses achieved a higher selling price. It is
important to note that buying a franchise does not automatically guarantee success. Some franchises are, to
say the least, not worth considering
at all. Another
factor is the required skills that the Buyer must have to run the Business. The higher the skills required of the
buyer, the less prospective buyers are available
and the price will be relatively lower.
- Asset
Value.
Asset
value plays a roll, but is secondary to Net profit. A business with an exceptional high asset value which
is running at a loss has very little Sales value,
except for the second hand value of the assets. On
the other hand you can have a Brokerage Firm with a high Net profit which is run from a one room office with a few
desks and a computer. The asset value of
such a business is very low, but the owner earns a hefty income each month.
- Trading
Hours.
If
you compare two businesses which have the same profit, but the one business is trading five days a week and the
other is trading seven days a week, then the sales
price must be adjusted upwards for the five day week business. Similarly a Business operating at office hours will be
more in demand than a Business operating
until 02h00 in the morning.
- Lease
Conditions.
The
reputation of the Lessor plays a roll in the pricing, as well as the lease conditions and the monthly rental
charged for the premises. The buyer must take note
of the annual escalation clause, the lease term offered as well as the clause allowing the owner of the business to sell
the business.
- Is
the Business Manager run or Owner Run.
If
the Business is Manager run, the owner has more time for himself. However an owner run Business has more control
over the business in terms of new initiatives, customer relations and day to
day business decisions.
- Debtors
and Creditors.
Debtors.
The age analyses of the business’s debtors have an influence on cash flow and cost of financing the
debtor accounts. Cash businesses are preferred. Debtors who include Government (health, education, etc.) and
Municipalities have a negative
impact on the price of a Business because of the perception of their
neglect to pay within thirty days from invoice. The
history of the amount of bad debts
will negatively influence the Sales value of a business. Creditors
outstanding will influence the price and cash flow of the Business.
- Stockholding
The
cost of large stockholding and the cash flow required to maintain large stockholding is always taken into
account. It must be remembered that on the day
of the handover of the business from the seller to the buyer, the agreed stock value might be present, but the fast
moving stock might be depleted. This requires
an additional amount of cash that must be injected into the bought business. The
buyer must ensure that the stock included in the Sales Price is calculated at Cost price and not Sales Price or
marked up price and if VAT on the price of
the stock, which is included in the price
of the Business, is inclusive or exclusive.
- Method
of Payment for the Business.
If
the Business is sold on installment, the price will be higher than for a cash
deal.
- How
long has the Business been trading?
A
business which has been trading for twenty years will have a higher price than a business which has been trading
for six months. (even with the same net profit)
- How
long did the seller have the business?
A
Business which had four owners in six years will achieve a lower price compared to a Business which had one owner in
ten years.
- Micro
and Makro factors.
Micro
factors are factors that you as business owner can control. Makro factors are the dangerous factors because you as a
business owner can not control it.
Makro
factors can be:
·
the building of a new
shopping mall which will draw away the business’s existing customers.
·
new major opposition opening
in the area of the business.
·
government legislation.
·
new trends, fashion or
styles
·
weather changes
·
labour unrest
·
BEE requirements
- Labour.
Due
to Governments draconian labour laws, the union’s unrealistic demands and South Africans low productivity,
Business is steering away from labour intensive
businesses. The cost of labour is just to uneconomical to employ a large staff complement in terms of
wages, union demands, strikes and low productivity
of South Africans. The
price of a Business is positively influenced when a business has less staff and which is more mechanized.
- Black
economic empowerment.
A
business which requires compliance with black economic empowerment is avoided and achieves a lower price.
It can be argued that a BEE compliant Business
can deal with Government and other Parastatal companies. The fact is that they are perceived that they fail to
pay within thirty days and the cost of doing
business with them is sometimes too high.
A
buyer of some businesses buys the business for an income for his family and to create jobs for his/her children.
He/she doesn’t want a stranger in the business.
In large companies this is not such a big factor.
- The location is important. A similar business situated at Kleinsee (which is a declining mine town with declining number of residents) compared to Vanderbijlpark can not have the same price.
- Security
plays a role in the value of a Business. Businesses
situated at a Taxi rank are perceived a higher security risk than
businesses in a shopping mall. It is also known that businesses at a Taxi
rank have a high number of passing trade. Depending on the buyer the
position can be seen as an opportunity or a threat.
- Written
and legally binding contracts that are
profitable and which can be taken over by the buyer will affect the Sales
Price in a positive way.
Determining
the Value of the Business (Sales Value)
The
most common calculation of determining the Sales Value of a Business is
calculated
by means of three calculations namely:
- Extra
earning potential
- Return
on investment
- Payback
period.
The tree results are added and divided by
three to get an average. This average is then taken and adjusted taking into
account:
- The
price achieved from the sale of a similar business with a similar net
profit.
- Taking
into account the factors as stipulated in the sixteen factors influencing
the Sales price of a Business mentioned above.
·
Extra
earning potential
This
calculation attempts to compensate for the risk of being in one’s own business.
It is an attempt to calculate the reward which is an extra amount over and
above what the buyer can earn if he/she invested the money or worked for a
salary.
It
takes into account the asset value, the net profit, the current interest rate
one would receive from an investment, the reward from standing in the business
(salary) and the length of time the Business has been in operation. This calculation
gives an indication of the Goodwill value.
·
Return
on Investment
This
method calculates the value based on a return an owner would expect for the risk he/she takes to run a business after
allowing for a salary. The asset value
is not a consideration.
·
Payback
period.
The
Valuation is based on the period one would expect to recoup your investment times the net profit. The asset
value is not taken into account. At
present businesses sell for eighteen to twenty four times their net profit.
Final determining of the Sales price of
a Business.
The above three values are added and divided
by three to get the average.
The average is taken as a basis and adjusted
taking into account the sixteen factors mentioned above which has an influence
on the sales price of a business. It must be stressed that this method is a
method to estimate the Sales Price or Sales value of a business. Other methods
can be used, but the influences mentioned above must be used to adjust the
Value to a more realistic figure.
We have been Business Brokers in the Vaal
Triangle for nineteen years. Contact us if you are a seller or a buyer of a
business in the Vaal Triangle.
Frik
Liebenberg Business Advisory Services cc 99/05522/23
Frik
082 556 8368
Elmien 074 373
1888
frik.christien@gmail.com S L M Building First Floor
www.liquorlicensing.co.za 2
Hobhouse street. SE 2
www.businessexperts.co.za Corner Hendrik van Eck Boulevard
Follow us on Twitter @licensingliquor Vanderbijlpark
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