Performance Vs Opportunity

24 Sep 2018 3:16 PMTroy Potter
Performance Vs Opportunity

Why you should consider buying a business that is not making a profit.

The first thing most business buyers ask me about a business listed for sale is how much profit does the business make ? closely followed by a comment on the valuation based on a multiplying factor they googled or one that a friend provided.

As with most things, the value in a business is always in the details. Historical financial statements are valuable to understand the business and prove it can generate sales, but buyers should use that information to forecast a profitable future based on the way they intend to run the business and how they will leverage it's assets, not as a guarantee of future performance.

In the following example I've compared two similar businesses which were recently presented to the same buyer. It has been simplified but is based on an actual situation.

Food Business 1 - price $230k

Nett Return to Owner $ 0.00 (break even)

Food Business 2 - price $190k

Nett return to Owner $140k

Opening hours, Equipment values and food offering was similar whilst the businesses for sale were located within 100m of each other. A profit performance criteria would see the buyer choose Business 2 because it is making money and has a better ROI.

If we consider some key details in the financial statements however, it soon becomes apparent that Business 1 offers a much greater opportunity and value for the buyer.

Food Business 1 - $230k

Revenue $1.5M +pa

Wages $850kpa

Owners Hours worked = NIL

Potential Wage Savings $350k

Potential Net Profit $350k

Food Business 2 - $190k

Revenue $750k pa

Wages $240k pa

Owners Hours worked = 2 x FT (Unpaid)

Unaccounted Owners Wage expense $120k

Likely Net Profit $20k

The potential Wage savings for business 1 are not a guess, they are based on ATO benchmarks and any restaurateur will tell you that a food business should run a wages expense of 35% of revenue or less. My point is that the opportunity available in Business 1 is more valuable than the proven performance of business 2.

In addition, not only is a buyer likely to make a better annual return on Business 1, but most buyers will use the Performance valuation method. So if the buyer can control wage costs and show a high net return they will also realize a much higher sale price when it's time to sell.

The above is a simple example but it applies to any industry and all businesses. If you only look at businesses showing good performance you might miss opportunities that offer much better value.

If you're considering buying a business on the Gold Coast or Northern NSW and think you might benefit from some industry insights, feel free to message me to arrange a confidential discussion.