Once ratios have been calculated using sample table above, it is time to start reconstructing company's financials by applying derived ratios to original amounts found in Financial Statements received from owner (see sample statements below). The amounts obtained by applying ratios are subtracted from original expense line values to deduct adjusted amounts. Use table below or a similar one to facilitate this exercise. Note that it is recommended to do above exercise using at least 5 companies from industry into which buyer is looking to purchase. Sample Financials Adjustment Table In this table, ratios can be calculated by dividing total revenue by each one of line items below. Note that Revenue in this context refers to revenue of a public company that is being used in benchmark. Data for this exercise can be obtained by visiting Internet (e.g., Yahoo!Finance). It is recommended that buyer calculate at least 5 ratios and use average to extract a more representative ratio. ======================================================================== OriginalRatioAdjustedAddback (Original - Adjusted) ======================================================================== Salary Repairs Office Exp. T & E Automobile Insurance Family Misc. Exp. Total (to be added to original net income) ======================================================================== Once reasonable multiples have been applied, differences should be added back to income statement of business. This will result in a noticeable increase in net profit, or a decrease in net loss, from Income Statement. As can be seen in case below, there is a sizable gap between Net Income on left and Adjusted Earnings on right. That adjusted number reflects a more likely income from business' operations if owner did not have to minimize income in order to reduce payment of business taxes. To help understand this better, reader should thoroughly familiarize him/herself with example provided below. It was taken from Valuation Analysis of a small chain of technology training schools, which author was advising. Once you have constructed an adjusted earning from business' financials, pricing can be made quite simple. We recommend that buyer apply a multiple ranging from 1.5x to 3.5x, to Adjusted Earnings. Using such multiples, a buyer is essentially paying a seller for right to collect business operating earnings in future. Assuming that business continues to operate forever, buyer is basically buying an unlimited amount of future cash for 1.5x to 3.5x its current net income. For example if your adjusted earnings are $50,000, your offer price might be between $75,000 and $175,000, depending on how strongly you feel about owning business and amount of cash you have to spend. However, if business operates for next ten years, for example, and continues to produce same (or more) amount of cash, buyer's potential total income from transaction could be $500,000 ($50,000*10) or more. Note that it is important to pay close attention to prices of comparable businesses in area where your target business is located. Also, note that multiples suggested above are simply guidelines. You may want to pay more or less, depending on how strongly you feel about business' prospects and future growth, and how you've structured transaction with seller. The reader might be asking why such emphasis on Net Income of a business as opposed to just valuing its assets. The truth is that, in addition to fact that some businesses, such as certain service businesses, do not have any hard assets, assets do not produce cash flow, revenue and income do. Although assets of a business are important, if they are not generating enough cash flow, they can not help buyer cover business expenses.

In addition, a business can generally find ways to generate revenues that its assets are not capable of producing. For example, a computer manufacturer may, in addition to selling computers, decide to provide computer maintenance services to its clients. Another example might be a Laundromat owner who decides to provide Dry Cleaning services by contracting out work to a Dry Cleaning Plant. In both cases, assets of businesses (e.g. computers, washers and dryers) do not produce income received. Because buyer is acquiring right to receive future earnings of business, its ability to produce cash is really what is important. As we can see, having your offer price dependent upon true income (or income potential) of business is essential. If your value is too low and you are unable to negotiate with seller, you may be missing on a great opportunity. On other hand, if your analysis results in overpricing business, you will be paying too much for a business that may fail after you have invested possibly all of your life savings into it.

People offering to do extra work only if they get paid for it, or take on extra responsibility only if their salary is increased first, have it backwards in my book. My advice: do work, do it well, and then do it even better. Higher pay, greater responsibilities and increased opportunities follow individuals who are contributors. Anytime I looked to hire people, offer permanent positions to temporary employees or interns, start up new departments or businesses, or promote individuals, I looked for people doing their job well ..."and then some.”

(c) 2004 Nan S. Russell. All rights reserved.