When looking to purchase a business you will see all kinds of terms, many of which don't make any sense. Here's a list of common terms and a rough idea of what they mean:
Cash Flow - this is the worst definition used. It's an attempt to convey how much money is available to a business owner after all the expenses of the business are deducted from the revenue. Unfortunately Cash Flow technically also would include any increase or decrease in working capital items like inventory, accounts receivables, etc.
Seller's Discretionary Earnings (SDE) - This is calculated same as above but would include expense items added back that are not important to the business operations. Usually these add back items are owners "perks".... country clubs, entertainment, etc.
EBITDA - This is ..(E) earnings (B) before (I) interest (T) taxes (D) depreciation (A) amortization. The I&T will be different for the buyer than the seller so they are added back and a buyer will need to account for there I&T costs based on their debt structure. D&A are added back because they are non-cash expense. Meaning you don't write a check to pay for D&A like you do for payroll or utilities, therefore the deduction in the expenses is not real dollars but actually a tax deduction. Unfortunately (or fortunately) this does not adjust for a fair managers salary. Most business book the owners salary as "what's left" after all expenses and this number can swing wildly from year-to-year.
EBITDA+OC - This is the best definition but the least used. It's EBITDA as described above PLUS the owner's compensation. This is the real comparison number that should be analyzed when investigating the profitability of a business.
Tuesday, November 13, 2007
Monday, November 12, 2007
How Profitable Can a Small Business Be?
I'm often asked this question.
For some reason many people believe a business has to be really big to make a great income for the owner, it doesn't.
Here is a sample of many types of business we see everyday.
Hours - 5 days a week 8am - 5pm
Sales per day $2,000 (that's $222/hour)
Annual Sales $500,000
Income to business owner $100,000!!
That's $200/hour = $100,000 per year!
Your business doesn't need to be big to be successful, it just needs to be good.
For some reason many people believe a business has to be really big to make a great income for the owner, it doesn't.
Here is a sample of many types of business we see everyday.
Hours - 5 days a week 8am - 5pm
Sales per day $2,000 (that's $222/hour)
Annual Sales $500,000
Income to business owner $100,000!!
That's $200/hour = $100,000 per year!
Your business doesn't need to be big to be successful, it just needs to be good.
What makes a small business VALUABLE!!!
Two things make a small business valuable:
- The amount of sustainable and growing profit it generates
- The ability for a potential buyer to see #1
Too many small business owners manage their business to "avoid" taxes when in fact what they are doing is avoiding "profits". If General Electric kept it's books like a many, many small businesses every manager in GE would likely be facing jail time!
Value in the eyes of the buyer?
- Can the real profit of the business be clearily and easily identified?
- Is there reason to believe the businesses profits can be repeated or improved upon in the future?
Simple questions but difficult for many business buyers to answer......because too many business owners "hide" profits in an effort to avoid taxes.
It's amazing to me, a business owner will pay his kids college out of the business and treat it as an expense (likely illegal but therefore avoid taxes on that amount) but then the biz owner doesn't fund his/her TAX DEDUCTBLE retirement plan which is totally legal!! Dumb.
Guess what, if you want to sell your business one day you will need at least 3 years of clean books to get the highest price for the business....that's three years!! And that doesn't mean go back 3 years and try to un-scramble your books, it means 3 years of clean books.
WARNING - most small business owners don't know when their business is going to NEED to be sold. Heart attacks don't give 3 year notices, in all likelihood neither do divorces, partnership break ups or all the other things that move a business owner to sell their businesses.
Want to have a better business that will pay you more now (yes, even after taxes) and get you the highest price when you sell?
Get a good accountant (no I am not an accountant), keep your books properly, take advantage of all the LEGAL tax breaks avaialble.
Make more money while you own the business, make more money when you sell the business and be a good corporate citizen along the way. What's not to like?
Start a business vs buying a business
Far more businesses are started than purchased. There are a number of reasons for this, some good and some bad. And far more start ups fail (about 15 times more) than do established businesses.
Often someone starts a business with very little capital and almost just as often the business fails due to lack of capital. The owner simply runs out of money before the start up gets to the point of positive cash flow. Starting a business with inadequate capital is often caused because virtually no lenders will lend money to a start-up. The reason? Because the start-up doesn't have a history of profits which would be available to pay back the loan. Pretty simple.
Example someone has $80,000 to start a business and they think it's enough to get the business started and operate until the business is profitable (more importantly - cash flow positive). So you sink in $80,000 and hope the customers like the product or service. WARNING..... the average time it takes a start-up to achive positive cash flow is about 3 years.
Now let's look at an existing business purchase. If a buyer has the same $80,000 they can borrow another $250,000 and purchase a business worth approximately $300,000 (Purchase biz for $300k and have additional $30k for working capital - total $330,000)! Why will a lender lend you $250,000 to buy this business? Because it has a proven history of making enough profit to pay the debt!! Not true for a start-up.
A business that sells for $300,000 will likely have a psoitive cash flow of approximately $108,000 per year ($9,000 per month). That $9,000 will need to pay for two things... debt and income for the buyer.
A Small Business Administration loan for the purchase of this business will have a monthly payment of approximately $3,235 ($250,000 loan at 9.5% for 10 years).
The positive cash flow per month that is available to the buyer, in salary, is $5,765 ($9,000 - $3,235 paid to bank to retire the debt).
So you have choices.... you can start your own business from scratch, throw in $80,000 and hope (and pray) that someday you actually have a profit or you can buy a business and have a profit from day one. Looks like an easy choice to me. But be warned - do your due diligence thoroughly before starting or buying a business!!! Where do you go to find businesses for sale? Just google buy a business in (your town here). You'll see lots of choices. Do your research carefully and thoroughly and you could turn your dream of owning your own business into a reality.
Let me know how things work out.....
Often someone starts a business with very little capital and almost just as often the business fails due to lack of capital. The owner simply runs out of money before the start up gets to the point of positive cash flow. Starting a business with inadequate capital is often caused because virtually no lenders will lend money to a start-up. The reason? Because the start-up doesn't have a history of profits which would be available to pay back the loan. Pretty simple.
Example someone has $80,000 to start a business and they think it's enough to get the business started and operate until the business is profitable (more importantly - cash flow positive). So you sink in $80,000 and hope the customers like the product or service. WARNING..... the average time it takes a start-up to achive positive cash flow is about 3 years.
Now let's look at an existing business purchase. If a buyer has the same $80,000 they can borrow another $250,000 and purchase a business worth approximately $300,000 (Purchase biz for $300k and have additional $30k for working capital - total $330,000)! Why will a lender lend you $250,000 to buy this business? Because it has a proven history of making enough profit to pay the debt!! Not true for a start-up.
A business that sells for $300,000 will likely have a psoitive cash flow of approximately $108,000 per year ($9,000 per month). That $9,000 will need to pay for two things... debt and income for the buyer.
A Small Business Administration loan for the purchase of this business will have a monthly payment of approximately $3,235 ($250,000 loan at 9.5% for 10 years).
The positive cash flow per month that is available to the buyer, in salary, is $5,765 ($9,000 - $3,235 paid to bank to retire the debt).
So you have choices.... you can start your own business from scratch, throw in $80,000 and hope (and pray) that someday you actually have a profit or you can buy a business and have a profit from day one. Looks like an easy choice to me. But be warned - do your due diligence thoroughly before starting or buying a business!!! Where do you go to find businesses for sale? Just google buy a business in (your town here). You'll see lots of choices. Do your research carefully and thoroughly and you could turn your dream of owning your own business into a reality.
Let me know how things work out.....
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