Know What Your Business is Worth

by WOHe

Know What Your Business is Worth

Chart A
Sales (total
business revenue)
$
2,440,000
less cost of
sales
(1,464,000)
Gross Profit
=
$ 976,000

less operating
expenses
( 732,000)
Net Profit
=
$ 244,000

Adjusted
Expenses
+ 165,000′

less new manager/owner salary’ (
75,000)
less cash reserve for new owner’ ( 50,000)

Adjusted Earnings
=
$ 284,000

Over the years, I’ve suggested to business owners that they
should always have a clear understanding of what their business is
worth. Consistently, however, I find that kitchen and bath dealers
do not have a clue as to the value they have created with their
enterprises. Not having a clue about such an important detail could
result in a lifetime of work and achievement never realizing its
full potential.

As business owners, we do more than sell kitchens. We do more
than meet payroll. We do more than work 10 or 12 hours a day.

As business owners, we create value.

I’ve told the story many times about the first time someone
approached us about buying our business. It was 1986, and our
design firm was only 3-1/2 years old. I remember that we were
working 80 hours a week, always running behind and, then, out of
the blue, someone wanted to know if our firm was available for
purchase.

I’m sure that my reaction to the question epitomized what is
known as the “deer-in-the-headlights” look. Luckily, I didn’t
verbalize what was racing through my mind You want to buy THIS
business?

I was just as surprised when we retained a business evaluator
and he presented us with his calculation of what our business was
worth. How could our business be worth that much? Did he seriously
think that someone would pay us that much for this business? But,
the fact is, someone did pay us that much. More importantly, I came
to realize that they weren’t crazy at all. The business we’d
created was worth every penny they had invested.

Understanding value
Since that time, I’ve made sure that I’m always aware of what our
business is worth. I suggest that this be a priority for every
business owner.

It’s always better to retain an outside professional to prepare
a business valuation for you. A trained professional understands
the marketplace and will be able to determine a defendable,
accurate value.’

If you would simply like to know the value “range” for your
business, try this formula, which we’ve worked with for a number of
years.

Start by getting two pieces of paper. Label one “tangible
assets,” and list, using your best estimate, the current market
value for your hard assets things such as computers, fax machine,
displays, etc. On the second page, tally every dollar that you, the
owner, take out of your business. Include salary, payroll taxes,
fringe benefits, etc. Make sure to include anything that was paid
out of the business checkbook but was actually personal in nature.
You should also note items from your financial statement that
wouldn’t be the responsibility of a new owner, such as interest and
depreciation.’

All of these will be added back to profit and are termed
“adjusted expenses.” When you’re done, your recast income statement
should look something like Chart A (note that we’re leaving some
money in the business for a new owner salary and some capital for
the new owner to operate with).

Developing a multiplier, the way to estimate the value of those
items that produce the profits, is also something that you can do
on your own. These items could include mailing lists, business
reputation, years of doing business, trained staff, marketing
materials, etc.’

Using a scale of one to six, answer the following questions (I
have given response examples):

Risk: Is there risk to the investment into your
company? Is there a reasonable chance that income will continue to
be produced? (Ex: 3)

Competition: Are competitive pressures such
that continued income is in question? (Ex: 2)
Industry: Is this a growing industry? (Ex: 4)

Company Standing: Is the company stable, and does it have a
solid earnings history? (Ex: 3)

Company Growth Potential: Is the company a
growing concern? Will it continue? (Ex: 2)

Desirability: Is this an attractive and
appealing place to work and conduct business? (Ex: 2)
Take an average of all of the answers to these questions (Ex:
2.83)’
To calculate the value of your company, get out your list of
tangible assets. Our valuation formula looks like this:

Multiplier x Adjusted Earnings = Going Concern Value

Going Concern Value + tangible assets + inventory + receivables =
Total Business Value

Be prepared
Even though it happened to us, it’s fairly unlikely that someone
will walk in one day and want to purchase your business. Normally,
a broker would be retained and a confidential marketing plan would
be developed and put in place.

According to business brokers, the average length of time for a
business to be on the market is 10 months. That means that the good
ones are snapped up quickly and the others take a while. More
significantly, brokers nationally are successful in selling firms
they represent less than 50% of the time. Brokers say that the
biggest hindrance to sales are businesses that demonstrate poor
record keeping and inattention to their financial statements.

Knowing what your business is worth is critical when you’re
seeking any type of financing. It is also an essential component of
estate planning. Understanding the value of your business is also
the best motivator I know of when you’re sure you can’t stand to
work with one more customer. So, start planning.

Steve Vlachos is a well-known industry author and educator who also
serves as an instructor for the ‘Managing for Profit’ seminar
series co-sponsored by K&BDN and NKBA. Vlachos heads Vlachos
& Co., which assists firms with business and evaluation issues.
He can be e-mailed at: vlachos@maine.rr.com.

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