In the last editorial I briefly touched on some concepts to help you better understand how a beauty business will have a market value, even if the business is not currently for listed for sale. This market value, can be easily calculated and assessed, with a Business Appraisal from a Licensed Business Broker, like myself (in most cases at no cost), or by having a Registered Valuation produced by a Licensed Valuation specialist (this can cost between $5,000-9,000). Also as mentioned in the last editorial, these business values are affected by the ‘weighting factors’ and risk profiles of the business, but are mainly determined by the business’ financial performance and profitability, which we are covering here in this editorial. The third and final aspect which makes up the business value is the value of the business assets and its stock. We will cover this final aspect in the next Issue.
The financial performance and profitability of a business is found within the Profit & Loss (P&L) Statement of the business’ end of financial year reports. The impact of these figures on the business’s market value is the most significant of any aspect making up the business value.
These P&L Statements will normally be prepared by a Chartered Accountant as part of the financial year-end reports. The P&L records all income, costs of goods sold, operating expenses and the profitability of the business.
Ok, let’s get into it…
There are many ways to increase the income of a beauty business, as most of you know. For some quick examples, Business Owners can increase marketing through avenues like Facebook and Google Ads and through targeted email marketing campaigns, with the existing client database. The business could run special promotions to gain new clients and/or add additional operating hours such as a late night or operating over weekends, to also further increase income. Business Owners should assess where the highest margin services are and focus in on this. You could look at hiring additional admin staff to free-up the higher income-producing staff who may currently need be pulled away from performing high-value services, simply to answer phones and update the Facebook page, which can be outsourced or delegated. Additional equipment could be introduced, allowing new or complementing services to further diversify and increase income. There are many ways to increase the income/sales/revenue.
This focus on increasing income is the starting point of your businesses profitability journey and features literally, at the top of the list on the P&L Statement.
You must accurately record of ALL income transactions, this is vital! If your intention is to add value to the business, resist doing ‘cashies’ (unrecorded income resulting from cash payments). When sales income is not recorded, it didn’t happen! Yes, I agree, good for a reduced tax bill (not recommending you do this), but terrible when it comes time to sell the business! Because the income cannot be substantiated, it therefore cannot be sold. If unrecorded cash sales are significant within the business, you could spend years operating a great little business like this earning decent money and when it comes time to maximise your last opportunity to make money with the business, you fail. The business which you know can produce an income of say, $250,000 can now only be sold as one capable of doing $150,000, because this was the amount run through the ‘book’. The buyer walks away with a bargain and you walk away bitterly disappointed. I have personally witnessed this on several occasions. It disappoints me and is a very bad idea.
Less: Cost of Goods Sold (COGS)
These appear directly under the ‘Income’ figures on the Profit and Loss Statement and are the costs related to the goods which were sold, or related to the services which were provided. The lower the cost of the goods sold, the higher your Gross Profit (GP) figure can be. The higher your GP total and G.P as a percentage of the total income, the more attractive your business will appear to investors or potential buyers the greater the chances of success when it’s time to sell.
Equals: Gross Profit (GP)
Gross Profit as mentioned above is the figure resulting from subtracting the Cost of Goods Sold (COGS) from total Income figure on the P&L.
Income … Increase this
Less: Cost of Goods Sold (COGS) … decrease this
= Gross Profit (GP) … have a better figure here. Better figure here helps create a better sale price.
Less: Operating Expenses
Now come the ‘Operating Expenses’. This is where it can get messy for some businesses. Like most business owners, this is the place where you may run your personal vehicle, phone and other ‘Discretionary Expenses’. Discretionary Expenses are those which don’t relate directly to business activity and/or, are not vital to the business operation. These can be totalled up and added back to the ‘Net Profit’ figure at the bottom of the Profit and Loss Statement, giving potential buyers an accurate depiction of the businesses true abilities to produce profit. This process we call ‘Normalisation’ of the accounts.
But these Discretionary Expenses, can be open to some level of interpretation and may not be agreed with a potential buyer, so there is an element of risk in ‘clouding’ the water’ on the P&L with these Discretionary Expenses, especially if there is a lot of them and they are not recorded very accurately. A business owner with lots of uncategorised Discretionary Expenses may not fully realise the full value of this/her ‘would-be’ profit after ‘Normalisation’, when it is time to sell. As attractive as the tax deduction advantages may be, keep in mind, the cleaner the P&L and accounting, the less risk for a buyer in accepting these normalised figures and the better the sale price, in most cases.
Online accounting tools such as XERO or MYOB are great for managing this area of the business. I believe the best way to keep the costs as low as possible in a business, is by keeping them visible. On any given day throughout the year, a business owner needs to be able to assess the current operating costs and determine whether these are eroding the profitability and therefore reducing the businesses market value and make adjustments throughout the year.
Equals: Net Profit
Net Profit is KING! The Net Profit or Earnings Before Interest and Tax (EBIT) is the last figure at the bottom of the P&L and is the figure, most commonly used to determine a business’s market value. This Net Profit or EBIT figure is multiplied by an industry multiplier, which has been determined by previous sales of businesses within the beauty sector or beauty business market. For example, a business with a Net Profit or EBIT of say $100,000, multiplied by the average industry multiplier of let’s say 1.98 for example, would provide a business expected market value range of around $198,000, there are other weighting factors as well, but you get the idea. Net Profit or EBIT is the ‘money shot’.
Profit & Loss Statement
Income – Always… In ALL WAYS!
Cost of Goods Sold – Lower is better.
Gross Profit – High percentage, more attractive to buyers.
Operating Expenses – Keep it clean and lower costs wherever possible.
Net Profit – This is your Bottom Line, now go and increase both it and the businesses value!
My advice for any business owner wanting to assess their position and business value would be to set a meeting with your Accountant and have the accounts brought up to date. If your accountant is a financial advisor, ask them to walk you through how your business is currently operating and see if there are some little ‘Value-Add’ actions you can make right away, which lay hidden within your business somewhere right now, which can quickly and easily increase your businesses value. Grab copies of the last 2-3 years P&L’s and sit down with a Business Broker for a business appraisal.
As always, I am here if you have any questions. Go add that value! See you next time!