How much should a business be sold if average monthly profit is $50k ?

5 years is usually about right, but I have seen some sell for 10 years, I have also seen some sell for 1 year profit. Depending on your location and the demand, you could create a bid war if the cards are played right. On the other hand it could back fire, the business might not be worth that much to potential buyers. I think you should test it out a bit, and see the reactions. Definitely wouldn't sell it short from the beginning.

Aim high and then refine to a lower point if necessary.

I would say that you could probably get 2 years worth somewhat easy, maybe 3. Currently though, I don't think you would get 5, but I may be wrong.

Also depends how much of the profits were solely down to the owners efforts ie if he? goes will the business decline rapidly or is there a structure for longevity and growth solidly in place so the business grows without him

Why does he want to let go of a business that nets him $40k a month?

Hell he doesn't have to be hands on use the profit to hre people to run it instead of him.

Hell even if he spends $30k on people to take over he still nets $10k+.

Never give up one business to start another. Build a business and than get hands off. That way you can start your next. Virgin is a classic example of this. Look at all the businesses under that name. He makes one and then another and another and another.

Never give up a profitable business if you can hire people to run it.

1 to 3 times earnings would be in target.

Is the business able to run without him present, or are the sales / profits being generated a result of customers mostly wanting to do business with HIM specifically. (personal relationships, etc.)

It also depends on if a business buying him out would be doing so for strategic vs. financial reasons.

~Dexx

Sort of.... Usually, in the M&A (mergers and acquisitions) world, it's referred to as a multiple of single year annual earnings. So 1 to 3 times earnings would simply be a multiplier of the current, last year of earnings.

That's because 3 years of earnings into the future could radically change. The only thing you have to go on that's concrete is the last year of audited accounting. So, 1 to 3 times whatever the last year of audited earnings... in some cases add the additional asset value of the company over and above.

Of course, different industries can bring different valuations and formulas.

Once upon a time, you could look at the P/E ratio of a public stock to see what multiple of earnings it was trading at. So if there was a stock that earned $1 per share in profit that was trading at $15 per share, the P/E ratio was considered 15:1.

The .COM era changed all that and created a market tolerance for public companies that traded at high share valuations while losing money hand over fist. So I am not sure what true value a P/E ratio actually has anymore.

But in the broad sense, it's the same idea for even your friend's business.

Naz,

I think you are looking at this way too simply to just calculate the value of the business by just using a multiple of current profits. Using a multiple is a great way to get a quick estimation, but anybody who is buying the business will probably want to do a much more detailed discounted cash flow analysis to figure out the true value of the business.

To do this you will want to look at future cash flows and then discount them back to a present value. Profit looks at how well things have performed in the past. To get a true value of the business you need to make some assumptions on how well it will perform in the future and then discount those future dollars to today's price. (A dollar today is worth more than a dollar 3 years from now because of inflation and opportunity cost.)

So real quickly, let's make some assumptions for easy math.

1) Currently grossing $75,000 a month for a total of $900,000 a year.

2) Cost of goods sold is 25%

3) Labor and other expenses is $10,000 a month for a total of $120,000 a year.

4) We'll use a conservative growth rate of 3% (this number will be used to calculate the growth of revenues over the next 5 years, as well as the increase in labor and other expenses.)

5) The opportunity cost, or cost of capital, is 10% (This is a HUGE assumption that should be played with.)

With these assumptions I come up with the following numbers:

Year 1 after Sale
Gross Revenue: $927,000
Cost of Goods Sold (25%): $231,750
Labor & Other Costs (includes 3% increase): $123,000
Net Income: $571,650
Net Income in Today's Dollars: $519,682

Year 2 after Sale
Gross Revenue: $954,810
Cost of Goods Sold (25%): $238,703
Labor & Other Costs (includes 3% increase): $127,308
Net Income: $588,800
Net Income in Today's Dollars: $486,611

Year 3 after Sale
Gross Revenue: $983,454
Cost of Goods Sold (25%): $245,864
Labor & Other Costs (includes 3% increase): $131,127
Net Income: $606,463
Net Income in Today's Dollars: $455,645

Year 4 after Sale
Gross Revenue: $1,012,958
Cost of Goods Sold (25%): $253,239
Labor & Other Costs (includes 3% increase): $135,061
Net Income: $624,657
Net Income in Today's Dollars: $426,649

Year 5 after Sale
Gross Revenue: $1,043,347
Cost of Goods Sold (25%): $260,837
Labor & Other Costs (includes 3% increase): $139,113
Net Income: $643,397
Net Income in Today's Dollars: $399,499

So to get the total value of the business today, you want to add up all the Net Income in today's dollars: $519,682 + $486,611 + $455,645 + $426,649 + $399,499 = $2,288,086

One thing to note is that this number is slightly understated because I didn't include a terminal value, which is the present value of all the future cash flows after 5 years. Even though revenues will be increasing, the further out you get the present value is worth less and less. There are a bunch of math formulas to calculate this involving different risks and all that, but I'll spare myself and everyone else the pain!

There are also quite a few different expenses to think about like capital expenditures (for when the yogurt machines need to be replaced, updating the store, etc...) that will influence the actual value of the business . Taxes also play a big part, which I completely left out.

Overall, when you add in the cash flows past year 5, I would say you are looking at a value of approximately $3 million for the business. Now whether you can find a buyer for that price is a whole different story!

Obviously my final number came within the range of using a multiple, but I wanted to share this information to illustrate the point that when selling a business that is close to a million dollars in yearly revenue, there should be much more analysis than just a simple net income multiple.

If anybody has any questions, I'd be happy to answer.

Best of luck to your friend in selling the business, I hope I was able to help and not just confuse or frustrate!

-Ben

That's a very good question, I should have explained that part better.

I used a 10% opportunity cost of capital to determine the present value (PV) of the future cash flows.

The specific formula for present value is: PV = Net Income / 1 + Opportunity Cost of Capital

For example, Year 1 for this formula would be: PV = 571,650 / 1.10 = $519,682

The 571,650 is the estimated net income and the 1.10 is 1 + the 10% Opportunity Cost of Capital.

For year 2, you have to expand the formula to be: PV = Revenue / (1 + Opportunity Cost of Capital)^2 [Note: the ^2 means squared, for year 3 it will be ^3 (cubed) and year 4 will be ^4 and so on]

So specifically for year 2 the formula would be PV = 588,800 / (1.1)^2 = 486,611

Year 3's formula is: PV = 606,463 / (1.1)^3 = $455,645

I hope that makes sense mathematically.

Conceptually, think of it this way. Back in 1940 you could buy a McDonald's hamburger for 5 cents, so you could get 20 hamburgers for a $1. Nowadays if you want to buy a regular McDonald's hamburger it will cost you $1, so you will only get 1 burger for $1. Back in 1940, when you could get 20 burgers for $1, the dollar was worth more, meaning you could get more for a dollar then than you can now.

This principal applies going forward. $1 today is worth more than $1 in 5 years from now. There are obviously a lot of factors that affect this, but that is included in the 10% opportunity cost.

Specifically for the opportunity cost, that is the other things people could do to invest their money to make it worth more. If they use the money to buy your friend's yogurt shop, they won't have that available to make other investments which could yield them a return. They will miss "opportunities", which is why it is called the opportunity cost.

I hope that all makes sense. The concepts here are actually very advanced financial concepts and aren't super easy to explain. Your friend's CPA can probably help him with this type of analysis. In fact, I would hope he would, because the more detailed the analysis, the better the information your friend will have when he is negotiating the final sale price of his business.

-Ben

I came up with approximately $3 million because the value I calculated for the business was $2.28 million, but that only included 5 years cash flow. In reality, the business will make make money for more than 5 years (assuming it stays in business), so if we don't count the cash flows from past 5 years we are undervaluing the business. I added ~ $750k just to make it simple. (And I realized how long my post had become and how much time I already spent on it that I didn't want to spend any more time calculating out a terminal value!)

Anyway, I hope I helped in some way and didn't just confuse.

-Ben

No problem!

You're right, the big test will be whether he can find somebody to buy it. The good thing is that Yogurt Shops are really a hot market right now, at least where I live. The bad news is it's the dead of winter, so he might not get as much as if he waited until Spring, when Summer is around the corner.

-Ben

Depends on current economic conditions, previous sales of similar businesses, demand for that type of business, location etc. In current economic times, 2 to 2.5 years of revenue is about the average. Best to speak to an accountant to do a proper evaluation and place a value on the business.