“I Wanna Buy a Business”
It appears the economy is picking up because I’ve been getting a number of inquiries about people wanting to buy a business.
Lets look at Jack Reecher who visited me recently, he’s ex military been bumming around for the last ten years getting himself into all sorts of trouble, as a result his health is not good, he's managed to acquire a house that he can use as security, but has no savings.
Jack’s found a business that appeals, he’s had a chat with the owner that tells him its a beaut business with plenty of cash flow, the owner does his own end of year accounts, the figures show a turnover of $500K and after business expenses, a profit before wages and tax of $120K. The owner also informs Jack that he takes $800 a week under the table. He's also taken on a worker paying him $30k per year, he predicts that his profit will increase by a further $70K, including the under the table income and with the predicted increased income the business is going to earn a profit of $200K or so the owner reckons. Based on this, the owner wants $600K, three times the projected profit. Jack asks me for my opinion.
Well Jack there’s a few things you need to understand when buying a business. You can't value a business on projections or supposed money under the table. It is valued on fact. If the owner does his own accounts we need to look at his GST returns filed with Inland Revenue, hopefully there’s going to be some truth to them, how do they compare with the accounts, do the sales correspond? How does the business compare with industry standards? Waikato University benchmarking survey is a good place to start. As an accountant we know where to access these standards.
Valuing a business is a logical process based on particular formulas to suit various situations. On this occasion we would look at the profit. Take out costs synonymous with the current owner. As no remuneration has been included in the accounts we would make an allowance for this based on a market salary, add in costs that Jack would incur, such as financing costs as it’s likely that Jack would have to borrow money to buy the business. Once we arrive at an adjusted profit we would then look at the assets and liabilities of the business and make an allowance for them.
If Jack were to get finance he'd have to repay the business loan over 7 years and at the asking price of $600K his repayments would likely be $8980 per month, a big portion of his profit, with little left.
Jack, why do you want to buy this business? "Well I like the idea of earning all that money." Do you realise owning a business is not a 9-to-5 exercise, it requires a lot of time and effort, more importantly, how is your health? "Not good, I have some real crappy days, my drive and ambition to succeed is not what it used to be. On reflection I don't think it's for me."
After looking at all the facts and talking them through with someone who understands businesses and the commitment required, it is little surprise many people choose not to allow the vendor to talk them into buying a business and simply walk away a few dollars poorer and a lot wiser.
By Dennis O’Grady
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Posted on Mon, 1 September 2014
by Dennis O'Grady