An increasingly common method for business valuations is the EBIT multiple, in which the value of a business (or sale price) is calculated based on a multiple of its earnings before interest and tax (EBIT).
As shown in the latest BizExchange Index released this week (refer to last weeks blog), this valuation method is invaluable when looking to compare business values across a variety of industries.
This is particularly true for business values particularly in an age where traditional business assets like real-estate, plant and equipment are no longer on the balance sheet as assets. Indeed, many of these items now appear as ongoing liabilities on the balance sheet in the form of leasing contracts. This often means that a business with few assets has more ongoing liabilities on its books than it has forward sales, presenting a negative balance sheet. So rather than look at the net assets and then add a good-will figure that is the difference between the net assets and the sale price of the business, the EBIT multiple is now being used to good effect.
However, like some superannuation funds, some businesses are now looking down the barrel of negative returns – they certainly do not want to multiple a negative number as a basis for a sale price! And if some of these have a negative asset base, which is not uncommon in the retail and business services sector, then they may have trouble finding a buyer. So what is a reasonable price for a business that has failed to make a profit?
In this climate it appears to be not much. The business headlines have presented a string of mid-size companies with established brands who have not been able to refinance and then are unable to find buyers either. The blue-sky potential that was so easy to sell 12 months ago is now unsalable as the storm clouds of recession gather.
What is in demand right now is cashflow, and cash-flow with a present, a history and a future is preferred. If you have not got a positive cash-flow, then don’t expect to get much for your business.
If your business is generating strong cash-flow and double digit return on investment, then that is another story altogether.
The key issue here is looking at your timing. Cash is technically getting cheaper (as measured by official interest rates), but it is also getting scarcer as financial institutions tighten their lending criteria – this is making a cash generating business more valuable.
So if you are looking to sell a good cash-producing business you will be able to find a buyer. On the other hand, now may be an excellent time to expand your business through selective acquisitions to be ready to power into the next upswing in the business cycle.
It makes for an interesting time in Australia’s private business market, one in which the prices of individual businesses are likely to diverge markedly from the official average.
Andrew Kent is a director of BizExchange, an independent marketplace for business for sale or seeking investment. BizExchange has a directory of independent advisers and business brokers and information on valuations.