Business Valuation – Profit and Multipliers
This month we are taking a look at how we approach business valuation using adjusted net profit and finding the correct multiplier.
When valuing businesses the correct adjusted net profit is the valuer’s assessment of the profit of the business. Adjusted net profit is the profit after adjustments have been made for abnormal and non-recurring expenditure. These include finance costs, rent (where appropriate) and depreciation relating to the property itself.
Adjusted net profit gives the valuer an indication of the fair maintainable operating profit (FMOP, more details here) which is used to calculate the Business value.
The difference between the net profit and adjusted net profit is the costs that are personal to the way in which the owner has chosen to run the company and issue accounts. To create the correct adjusted net profit, all of the current owners expenses must be deducted.
|Rent Payable (Office)
|Adjusted Net Profit
- Rent payable is a separate office rented by the owner.
- The office is not used for the running of the business
- Managers wage is paid to the owner.
- Loan interest is from the loan taken by the owner to buy the property and business.
- Directors’ remuneration taken by the owner for personal use.
None of these costs are costs of the business. Therefore, they are added back into the net profit to create a more accurate representation of profitability.
A typical valuation will look at the historical accounting figures and consider current management information. Calculation of adjusted net profit would also take into account any one-off or capital investments and spread these over an appropriate timescale.
Finding the correct multiplier
How did you arrive at the correct multiplier of net profit? This is one of the most common questions in the valuation process. The answer seems simple. However, the use of the correct multiplier is what makes the difference between a good valuation and a bad valuation.
By analysing actual sales evidence from similar business or property sales within a suitable location, we can then extract the correct multiplier. The following table shows a series of sales within the pharmacy sector broken down for comparison:
|Date of Sale
|Adjusted Net Profit
The correct multiplier is extracted by dividing the sale price by the adjusted net profit. The sales evidence above is broken down by each component of the business so that a true comparison is made to the business that you are valuing. From the evidence above the multiplier is between 5 and 10. It is then down to the individual valuer to decide a value in that range.
This is where the skill of the valuer comes in. Using their experience within the specific business sector they will apply a multiplier that they believe reflects the current business.
Septembers article: How to value your business
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