THE TRUTH ABOUT BUSINESS VALUE

Ralph and Shirley owned a gift shop. They came to me discouraged and defeated. They laid their tax return upon my desk and then proceeded to point out that their net income was about $25,000 for the past year according to their tax return. They went on to tell me how they both worked full time in this gift shop, 6 days a week, except for a couple of buying trips that they made each year. They had calculated that (based upon the hours they were putting in) they were not even earning “minimum wage.” They were wondering if they might be better off going to work for McDonald’s.

I said, “Wait a minute, your PROFIT OR LOSS STATEMENT in your tax return is meaningless as far as this is concerned. Your Profit or Loss Statement is NOT a statement of Profit OR Loss. It is (and probably should be called) A Statement Of Taxable Earnings. The PROFIT OR LOSS STATEMENT     (also called an INCOME STATEMENT) was designed for the benefit of the Government in order for them to determine your tax liability – and that’s all it is good for.”

THEY said: “What about our BALANCE SHEET?”

And they pulled out the balance sheet their accountant had prepared for them. It showed that, in their business, they had assets of $365,000 and liabilities of $325,000. Subtracting the liabilities from the assets – didn’t this mean that their business was worth only $40,000 – a business they had spent fifteen years building?

I said: “NO! You see this report was designed for the benefit of the money-lenders. They designed this to help them determine how much they can safely loan you – knowing that if they can encumber your assets – they won’t lose any money even if you can’t pay them.”

Ralph then asked in an upset tone: “Do you mean to say that our Profit and Loss Statement doesn’t tell us what we are earning and our Balance Sheet doesn’t tell us what our business is worth?”

I said: “That’s exactly what I mean to say.”

Ralph said: “Well, how can we know these things then?”

Well, this prompted a 3 week project during which we analyzed the true value of their business.

In Ralph and Shirley’s case, we determined that they were actually earning over $75,000 per year  – NOT the $25,000 on their Profit or Loss Statement – and we concluded that their business was worth over $250,000 – NOT the $40,000 on their Balance Sheet.

How could this be? Well, without getting too technical – we began by analyzing the tangible economic value of benefits that Ralph and Shirley enjoyed as a result of owning this business. This included over a dozen things – things like tax savings, a company vehicle, and travel benefits.

But, much more important than these tangible benefits were some intangible benefits. What Ralph and Shirley enjoyed more than anything was traveling all over the world visiting missionaries – often giving them unique gifts that they were able to obtain because of the type of business they were in. It was their business that enabled them to travel to visit these missionaries because twice a year Ralph and Shirley went on buying trips for their business. When I asked them if they would take ten times the income they were receiving – even based on our new evaluation – on the simple condition that they give up these trips,  they said they wouldn’t even consider it. This intangable benefit was worth more than anything else. Later, when health problems forced Ralph and Shirley to retire, this information about the true value of their business helped them get a premium price for their business–much more than they would have gotten if all they had to show potential buyers was their income tax returns.

Accountants, Business Brokers, Practice Management Specialists, and business schools have come up with literally hundreds of different “formulas” for determining the value of a business. For example, several of these formulas suggest that a business is worth a certain percentage of earnings. THESE FORMULAS ARE A FARCE if they fail to identify the true value of a business.

THE MOST IMPORTANT INFORMATION YOU CAN HAVE ABOUT YOUR BUSINESS is information that will help you determine the true value of your business. This information should influence every decision you make—including pay scales, capital investments, borrowing, marketing, etc. This information can help you determine if and when and for how much you might sell your business; it can help you determine how you should change your business or it can help you determine if it is worth it to continue your business.

If you are a business owner and you would like to know what the true value is of your business, please click  “CONTACT US” at the top right of this page or call us at (503) 927-2750.

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