Return on Investment when Buying a Business

What is Return On Investment

“Return on Investment a ratio between net profit (over a period) and cost of investment (In business and accounting, net income is an entity’s income minus cost of goods sold, expenses, depreciation and amortization, interest, and taxes for an accounting period)
In business, the purpose of the return on investment (ROI) metric is to measure, per period, rates of return on money invested in an economic entity in order to decide whether or not to undertake an investment. “(Wikipedia)

Why do people invest in the Stock Market? To get a return on their money invested.

Why do people invest in Real Estate being residential or commercial? To get a return on their money invested.

Why do people have savings invested with a bank or other investment businesses? To get a return on their money invested.

Why do people invest in anything? To get a return on their money invested.

Why do people buy a business? To get a return on their money invested mostly.

Buying a business is very much the same as any investment – to get a return on the money invested. Business buyers are the same as any investor. Investors don’t love the stock market, property, bank or Investment Company. They simply want a relatively safe return on their hard earnt money.

Buying a Business is not any different. Purchasers are investors. They do not love you, rarely love your business like you do and are only interested in the return on investment or potential return on investment.

When thinking of selling your business you have to first take away the emotion and put the purchaser’s hat on.  Is this a good investment? What return am I going to get? What do I have to do to get it? What is the risk factor of purchasing this business and the business continuing to generate the same or more income?

Is the business totally reliant on the current owner, location, staff, customers, suppliers, lease, stock, etc, etc. 

MOST IMPORTANT QUESTION A BUYER WANTS TO KNOW – WHAT IS MY RETURN ON INVESTMENT?

I believe Most businesses do not sell because they are overpriced or have not answered all the previous questions.

Currently only one out of every five businesses listed for sale actually sell. WHY?

Business buyers are investors and most businesses do not show enough Return On Investment.

Return On Investment is determined by the Total Funds In a buyer must have to take over the Business

TOTAL FUNDS IN (or amount the buyer must have to start with generally)

  1. Purchase price
  2. Stock Value ( in most cases)
  3. 3 Months’ Rent ( 1 & 2 for bond or security)
  4. Working Capital ( Money required to run the business for at least 6 weeks)
  5. Debtors ( if the business runs accounts)
  6. Legal / Accounting fees 

When you add it all up and determine the total funds actually required to take over and operate the business – What is R O I?

FirstNormalise all the financials to determine the real NET PROFIT of the business.

Normalise (Adjust financials with add backs to actual expenses including wages in or out)

Second – After you have worked out the total funds required and net profit-

 WHAT IS THE RETURN ON THE BUYERS INVESTMENT?

In most cases this will determine if your business is saleable or not. If the R O I is not high enough, you may have to lower the sale price to get the ROI up. (Can also lower the stock sometimes)

If you want to sell your business or any business take your owners hat off, determine real net profit based on factual information that can be proven, work out ROI and good luck!

Find out more about how to prepare your business for sale

Certified-Business-Valuer-and -Business-Broker-Coffs-Harbour

Douglas McDonald

Business Valuation Specialist

If you would like to discuss anything in this article please contact me: