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What the Profit & Loss Statement Doesn't Tell You!!
Contributed by Sunbelt Business Brokers
One of the key mistakes that business Sellers make is to improperly
price their business, and, to not understand how and what a
reasonable price is.
One of the key mistakes that Buyers make is to assume that the
Profit & Loss Statements of a business will give them the
financial information that they need to assess value.
Profit & Loss Statements are not designed to tell you: "What a
business is worth" or even to tell you: "How much money the
business makes." They are designed to help an owner keep
track of the revenues and costs of the business in an orderly fashion
- but mostly to provide the financial information that a
business owner needs to provide to the Canada Revenue
Agency about their operations.
While this is critical and necessary information, it is
absolutely not what Buyers need, and in fact is often
confusing to Buyers, and sometimes also to their
advisors. What a Buyer needs to know is: "How much cash is available from
this business, after paying all of the operational costs;
that I can use to pay myself a wage, and service the
debt I have incurred to purchase this business ?"
This number is called a lot of different things - normalized
cash flow, discretionary earnings, free cash flow, and
others. We call it "owner's discretionary earnings", and
it is a key component to what a rational Buyer would pay for
a business, and equally as importantly, what you would get through the
"sober second look" of lenders, and other advisors in a transaction.
It is, however, only one element of value, and it is dangerous
to apply it by itself, or without considering other elements!
There is a reasonably simple way to get to this critical number.
Take the taxable net income of the company,
- add back the non-cash expenses (like amortization),
- add back the cash expenses that would not apply to a Buyer
(like interest payments),
- add back the Seller's wages (only one Seller),
- add back all personal owner's benefits (home office expense,
non-necessary travel, personal insurance, perhaps cell phone,
subscriptions, etc),
- double check that all family members working in the business
are paid "at market" wages - add or subtract to adjust,
- double check that things like rent are also "at market" -
add or subtract to adjust,
- and then look at the total.
Compare this with previous years' totals to establish consistency over
time, and there you have it - a basis for determining the
owner's discretionary earnings that are the heart of what
you are selling.
Remember, however, there may be more variables, such as: - owner relationships,
need to replace equipment, etc., that may come in to play here, but
the above calculation is pretty critical.
BEWARE, as a Seller, you will be, or should be, expected to prove
each and every one of these adjustments!
Having this information prepared for potential Buyers has great
value for you: it reduces the Buyer risk, which increases
their willingness to pay you; it gives you the opportunity
to show what your business really does; it shows you are
thoughtful and serious about selling; and it starts the
process of you being organized to survive the Due Diligence
process. It also allows you to work with the Buyer
to reasonably, objectively, get to what you both want -
a successful business transferred to a new owner!
Download a .pdf copy of this article.
WANT TO LEARN MORE: The London, Ontario office of Sunbelt
Business Brokers offers a free program called "Buyer 101". In that 2 hour seminar, we discuss only 4
key issues that are critical to a potential business Buyer - Importance
of Confidentiality; How to Determine Value; Financing a Purchase, and;
the Offer and Due Diligence process. These same elements are
critical to - and are the same for - business Sellers! Please
Email us or call: 519-473-2227 to register for the next course!
Erik Twohig, CMSBB President, Sunbelt Business Brokers of London
Sales Representative, Sunbelt Business Brokers Premium
134-4474 Blakie Road, London, ON, N6L 1G7
T: 519-473-2227 x 22 C: 519-670-9214
E: erik.twohig@sunbeltnetwork.com
Web: www.sunbeltlondon.com
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