Canadian Vending

Features Business Staffing
How Much Is Your Business Worth?

It’s an important question that business owners often find difficult to answer.


February 26, 2008
By Jon Ford

Topics

How much is your business worth? It’s an important question that business owners often find very difficult to answer.

How Much Is Your Business Worth?

How much is your business worth? It’s an important question that business owners often find very difficult to answer.

In theory, it should be fairly simple as it is probably the business owner’s most important and valuable asset. Surely, therefore, they should have a pretty good idea of what it’s worth?

Advertisment

businessworth Yet most vending operators struggle to come up with an accurate figure, and if they do it might be wishful thinking. Some like to believe that their business is worth whatever sum they think they need for a comfortable retirement. Others answer that they don’t need to know yet – they’re not planning on selling the business any time soon.

 But there are many reasons for vending and OCS operators to regularly value their business other than the obvious one of sale. A valuation requires consideration of many of the factors that govern the success of the business. These include how well the business is performing, what its potential is, and what opportunities are being missed.

If the business isn’t performing well, and if it has little potential, its value will be low. This usually gives business owners a strong incentive to improve its performance, both operational and financial, which in turn will improve its value.

A valuation is, in itself, a useful thing to have but it’s important to use the valuation process, and the consideration of all the factors that go to make it up, as an incentive to improve the business.
It makes good operational sense to value a business regularly, even once a year. A formal valuation may be time-consuming, but a valuation that provides a focus for performance can use assumptions and estimates and therefore be much less onerous and less expensive.

Once a valuation has been undertaken the first time, the same bases and assumptions can be used each year. The aim is to create a benchmark valuation process so that factors affecting the performance can be highlighted and evaluated on a regular basis.

Business owners should therefore understand the basics of business valuation so their expectations for the business are realistic and they can take steps to ensure the business is operating well and can reach its full potential, not just when
 

it’s time to sell.


An accountant can help with a current valuation of the business, as well as identify ways of increasing the value that are specifically suited to the business. Business owners can then undertake the process themselves each year, to help measure their success and growth, until such a time as when they do want to sell.

Understanding the value of their own business also allows owners to move quickly when acquisition opportunities arise – they are more likely to know what the real value of the opportunity is to their own business.

One of the most important factors in determining value is profitability, as long as profitability is matched by dependable cash flow. An increase in profit will generally lead to an increase in value.
However, this doesn’t mean that all businesses with the same level of profitability will be valued at the same amount. For example, there may be a successful vending company (company A) in your town.  Another vending company (company B) is located next door and is equally profitable. However, company A’s profitability is closely related to the owner’s personal skills and relationships. While company B’s profitability is based on product pricing, account mix and corporate structure.
 
In today’s marketplace, company A is probably worth less than company B, despite the same level of profitability. The reason for this is, with the departure of company A’s owner it’s more likely that the profitability will suffer. The business owner needs to be able to show the quality and skills of the rest of the staff, the contribution they make to profit, and the lack of reliance on his or her own personal efforts.

Thus, while profitability is important, it is the expectation of continued profitability from the business structure itself, rather than from the ability of the present owner, that is most important.
This can come as a surprise to many vending operators who have worked hard to build up the long-term profitability of their business but in doing so, have become closely associated with the success and profitability of their business.

It is a particular problem with other professional service businesses as well where the reputation of the owner is closely associated with the business’ success. So the owner needs to reduce his influence on the profitability of the business in order to maximize its value. For example, by establishing a management team, improving formality of management, introducing customers to others in the business and keeping records of customer contacts, and excluding the owner’s name from the business.

A business that has good systems, is well located and enjoys a long-standing reputation should be able to maintain its profits, and such a business would usually be said to have a low risk.

Because of this low risk, the value of the business will be higher than that of a business where there is a high risk that the profit may not be sustained. The future profits of a business that has just started will be high risk, as will a business that has a low barrier to competitors entering the marketplace or a business subject to seasonal or weather fluctuations.

So, if a business valuation identifies factors that would put the earning of profits at risk, steps need be taken to minimize the effect of those factors in order to enhance the value of the business.

Business Value


The value of a business is often expressed as a multiple of the profits of the business. The lower the risk of earning those profits, the higher the multiple. For example, the value of a business in a particular industry may be four times its earnings before income tax (EBIT). And so the business would be earning 25 per cent on its value. A more risky business may only be valued at three times EBIT, representing a 33.3 per cent return on value.

The measure of profit used in the valuation calculation must exclude any ‘abnormal’ income and expenses, as well as interest. In some cases it can also exclude depreciation and amortization of fixed assets. But it must include a deduction for the commercial remuneration paid to the owner.
Often the driver of the owner’s remuneration is to minimize tax, and bears no resemblance to a remuneration that would have to be paid to an employee under-taking the same tasks. In other cases, businesses are run at a level where the owner’s remuneration is acceptable to that owner but would be unacceptable to someone else. So in valuing a business consideration must be given to the time and effort put in by the owner (and owner’s family) and an adequate reward must be identified.

In the process of doing this, it’s common for the business owner to realize that their reward really isn’t sufficient and they then look at ways to increase it. These include employing others to do more of the administration tasks, delegating management to others, introducing more efficient accounting processes, and working more “on” the business rather than “in” the business.

The difference between the calculated value of the business and the total value of its tangible assets, such as stock, debtors, and plant and equipment (less creditors) is the business’ goodwill. If the calculated business value is less than the tangible assets, the goodwill is negative. So goodwill is not something that is calculated directly but is the result of the calculation above.

The value of goodwill is enhanced by improving the business value through factors such as those referred to earlier, including handing over management to others to reduce the owner’s personal
association with the business.

If it appears that accounting records are unreliable, or if the business can’t produce current financial accounts, any prospective purchaser is likely to discount the value of the business because of uncertainty about its real profitability or even its legitimacy. It is therefore important that a business maintains reliable accounting records and can produce current financial accounts at any time.

As mentioned earlier, in looking at profitability, adjustments are commonly made for extraordinary items of income or expense and for expenses that are discretionary or personal to the business owners. For example, if there were motor vehicle expenses or overseas travel expenses for the benefit of the business owner, they would be added back in determining profit. Therefore, such expenses must be readily identifiable.

The availability of financial analysis of sales by customer, product, and geographic location, can also enhance value where the analysis points to a “low profit risk” due to a good spread of customers or wide product base.

Given this process, it is easy to see that many of the businesses offered for sale are not seriously for sale. Owners have nothing to lose, and so they may test the waters to find out about the sale process and see what their business might be worth.

As a buyer, I’ve sat through many lunches with these tire kickers only to find that they have no intention of ever parting with their companies. Maybe if they could receive three times what the business is worth, they might think about it.

As a seller, if you go through a broker, realize that you have done nothing to signal to the buyer that you are serious about nailing down a deal. In fact, using a broker signals just the opposite. Assuming you are not a tire kicker, you need to do everything in your power to let potential buyers know you are serious about selling. Do your homework and it will pay off down the road.
So find out what your business is really worth and use the valuation as a tool to improve your bottom line.