I am not a gentle man, I am a business man. My keen interest has been consulting and training for corporate organizations. Rarely, have I have done anything beyond this two recently except may be when I am with friends or families. I like to think of myself as a busy man, so I try to satisfy my inner thought by working on something every time. This piece is not about me but I have to write a good introduction if i want you to enjoy the article. I am sure you get my drift.
Towards the end of every of my class, I often create time for a session I called “lost-question” time. Don’t bother to ask Google what “lost-question” is/was, I invented it. It is a term I invented for questions that are outside the curriculum of my training outlines. I know there are participants who might have questions that are bothering them or a certain challenges which has nothing to do with the scope the class, I normally create few minutes at every class to answer “lost-questions”.
This particular day of all days was different because I noticed one of the participants has been itchy to ask me a question that is not related to what we have shared in the class, but I kept telling him to hold on, “I will create time for your question, sir” I told him. You might want to ask how I knew he wanted to ask a “lost-question”. Well, let us just call it professionalism. Eventually, he got his moment, I took the privilege of sharing his questions and an elaborate response to the questions in this piece. I hope you find it useful.
I am looking into trying to buy an existing business. The owner said to make him an offer, but I’m not sure of the best way to determine the worth of the business. Do I ask to see his books or do I value it based on the existing clientele? What kind of time frames do I need to have to make this a reality? Once I have an offer and it is accepted, where do I go from there?
A: Hold it right there! You are asking too many questions at the same time. I am not an entirely jug of knowledge like the computer or Encyclopaedia- even if I am- we still need to take it one after the other. So let us get to your questions one after another…
There are a lot of ways to value a business. There’s no “right” way, though you could probably come up with several wrong ones. Ultimately, the business is worth whatever you think it’s worth, based on the criteria you set forth. But you can make your estimation by using several different ways to value the business and then choosing the mix that reflects your final value estimate.
You can start by looking at the value of the business’s assets. What does the business own? What equipments? What inventory? After all, you’d have to buy all the same stuff if you were starting the business from scratch, so the business is worth at least the replacement cost. The balance sheet can give you a good indication of the value of the company’s assets. If the company doesn’t have a good set of books, think twice about buying it. You can get badly burned if the current owners don’t even know accurately whether or not the business is profitable.
The other valuation approaches all think of a business as a stream of cash. They value a business by trying to come up with a value for that stream of cash.
Revenue is the crudest approximation of a business’s worth. For instance, if the business sells N100,000 per year, you can think of it as a N100,000 revenue stream. Often, businesses are valued at a multiple of their revenue. The multiple depends on the industry. For instance, a business might typically sell for “two times sales” or “one times sales.” If you have a good stockbroker, he or she may be able to help you research typical sales multiples for your industry. A good business broker can also help you if he or she has done valuations in the industry you’re investigating.
But alas, revenue doesn’t mean profit. If you’re in doubt, just look at Amazon.com: It had 2002 sales of almost $4 billion, but no profit. In fact, it hasn’t made one cent of profit since the day it was founded. How much would you pay for an ongoing $4 billion per year that you have to pump an additional $380 million per year into just to keep it afloat?
That’s why earnings matter and why multiples of earnings may be a better way to think about valuation. If a company had a profit of N10Million, that cash can be used for growth or dividends to you, the shareholder. Estimate the earnings for the next few years and ask how much that income stream is worth to you. Be careful, though. Don’t just assume earnings will be stable. Competition, supplier price changes and a declining industry can affect earnings. Make sure to reflect that in your projections.
Let further explain by sharing with you my research a business tycoon, Warren Buffett. He uses what’s called a discounted cash-flow analysis. He looks at how much cash the business generates each year, projects it into the future and then calculates the worth of that cash flow stream “discounted” using the long-term Treasury bill interest rate. There’s no room to explain the theory or calculation here, but you can do it in Excel using the NPV “net present value” function.
I would have loved to show how to do this calculation but I would be doing and extra work to show the technicalities that would probably take another few hours. Nevertheless, I would entertain any further questions at the comment session.
I should have asked you this question at the begining or in the middle of this piece but since I don’t want to assume any intelligence, it is not too late to ask now, “Have you ever nurtured the thought of buying up an existing business?” or “Have you noticed a dying business that you would have loved to save?” Think about it!