If one is buying a manufacturing, wholesale, distribution, mail order, or on-line business it is important to benchmark key variables to determine the true value of the company. Key variables include the property (whether leased or purchased), equipment - storage, material handling, automation, and manufacturing as applicable; inventory - products for sale and/or raw materials and supplies as applicable; staff & payroll costs, employee contracts, employee proficiency; and technology (hardware, software, electronics, and accessories).
Property: When considering a business for purchase, the value of the total property or of the lease is a prime factor. Considerations should include:
> The cost of the property compared to similar properties in the same locale or the cost and length of the lease vs. comparable properties in the same locale to determine the relative property value for your situation.
> Cash flow – if the added cost to own the building will consume your available cash and/or the additional money to be borrowed and the cost of borrowing the money will leave you short of cash needed for marketing, inventory, equipment, or to add key staff, it may be preferable to lease.
> Space is valued by the cost of the property or of the lease. Space also should be valued in the context of growth. One should determine for how many years the space can support future business based on the company’s growth plans. If the business will outgrow the space soon after the purchase, one must add all associated costs of moving or adding space (if possible) to the cost of the deal or purchase a different property.
Equipment: > The value of production, storage, and material handling equipment is typically calculated by its original cost less depreciation. > Equipment originally purchased for $30,000,000 many years ago may have a present book value that is considerably less now, and that value must be determined based on local accounting rules. > The operational value of the equipment (its ability to provide required speed and productivity levels to meet present and future customer service requirements) is far more important than the cost of the equipment. The equipment must provide your company with a competitive edge or you will have to upgrade or replace such equipment (and at what cost) to be competitive. > Obsolete equipment will be detrimental as it must be disposed of which can be expensive and should be deducted from the purchase price.
Inventory: > Most businesses determine the value of the inventory whether for products for sale or for raw materials by reviewing the invoices for their purchase and then taking a physical inventory to ensure the amount on hand for each item matches the quantity listed in the company’s perpetual inventory. > When analyzing the real inventory value, one must establish the relevance of the inventory as well as the dollar cost. Obsolete material, last year’s model, and overstock (cannot be sold in a reasonable amount of time) will all reduce the value of the business. An inventory aging report is essential to determine non-saleable products and/or overstock. > If 25% of the inventory value is for items no longer saleable or for overstock that will take a very long time to sell, the value attributed to inventory as part of the purchase price of the business should be reduced by 25%. The real value of inventory is that of saleable items in proper quantities.
Staff: > It is one thing to determine the cost of the staff by reviewing company payroll records, but the real value of the staff should be judged by its relative productivity, contracts, and rules. > Having lower cost workers is irrelevant if they under produce the competition and labor costs per unit are higher than the competition. > One must benchmark the cost per unit produced vs. either industry standards or that of similar businesses in the same locale to judge the staff’s real value. > Employee contracts must be examined to ensure that key employees will remain with the company after its purchase and to determine future obligations to them. > Capabilities of key employees must be ascertained. If they are not capable of producing desired results for the way you will be running the business, they may have to be replaced or additional staff may have to be added, both adding to the cost of the business > Union agreements (if applicable) must also be examined to determine future obligations both monetarily and otherwise. What will your power position be, is the union friendly or hostile?
Technology:
> Business management, operations and communications software and hardware must be valued by how well they support both current and future business requirements to determine their real value, not by their cost. > A gap analysis must be performed to determine if and/or when current software should be modified or replaced. To do this, each key function that is required from the software module is measured by how well and how complete the software supports all user requirements. A “gap” defines missing functionality, speed, capacity and/or capability. > Many companies make a mistake by performing the gap analysis for current business requirements only. Proper gap analysis should be performed to meet future business requirements and volumes so as the business grows the systems purchased will provide proper support for the foreseeable future. > The same holds true for IT hardware. Servers should be sized for future business models and volumes, bar code scanners might have to accept RFID or other new technology in the future as well, and printer capabilities, specifications, and volumes may dictate higher level equipment. > Proper security is now vital. How vulnerable is the system to data breach or hacker intrusion and if there are issues what changes are required and at what cost to remedy the situation? > The cost for any additional IT equipment needed immediately or in the future should be added to the purchase price of the business.
By bench-marking all key variables one can determine the proper price to pay for a business and avoid many problems as well