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HowtoValueaBusinessforPurchase
Thisarticlediscusseshowtovalueabusinessforpurchase.Themostdifficult
stepinbuyingorsellingasmallbusinessisprobablydeterminingwhatthe
businessisworthasagoingconcern.
Manyjudgmentdecisionsmustbemade.Yetbeforenegotiationscancontinue
successfully,avaluemustbeestablished.Thevaluemustbeacceptableto
bothbuyerandseller,orfurthernegotiationisfruitless.
Itmustresultfromthelogicalandobjectiveeffortsofallthepartiesinvolved.
ValuationMethods
Therearetwobasicmethodsofdeterminingthevalueofabusiness.Thefirst
isbasedonexpectationsoffutureprofitsandreturnoninvestment.This
methodispreferablebyfar.Itforcesthebuyerandsellertogiveatleast
minimumattentiontosuchfactorsastrendsinsalesandprofits,capitalized
valueofthebusiness,andexpectancyofreturnoninvestment.
Thesecondmethodisbasedontheappraisedvalueoftheassetsatthetime
ofnegotiation.Itassumesthattheseassetswillcontinuetobeusedinthe
business.Thismethodgiveslittleconsiderationtothefutureofthebusiness.
Itdeterminesassetvaluesonlyastheyrelatetothepresent.Itisthemore
commonlyused,notbecauseitismorereliable,butbecauseitiseasier.The
projectionsneededtovaluethebusinessonthebasisoffutureprofitsare
difficulttomake.
LookingAhead
Whichevermethodistobeusedtovaluethebusiness,thebuyershouldask
thesellertoprepareaProforma,orprojected,statementofincomeand
profitorlossforatleastthenext12months.Forthis,thesellerwillpreparea
salesestimateforthisperiodalongwithamatchingestimateofthecostof
goodssoldandoperatingexpense.
Theprojectedstatementwillreflectthenetprofitthesellerbelievespossible.
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Thebuyershouldthenmakehisownestimateofsales,costofgoodssold,
operatingexpenses,andnetprofitforthenextyearatleast,andasfarinto
thefutureaspossible.
Inpreparingthesestatements,thebuyershouldstartbyanalyzingthe
actualstatementsofprofitandlossforatleast5yearsback.Heshouldbe
surethatthepastandprojectedstatementsprovidedbythesellerarecorrect
andareconsistentwiththebuyer'sproposedfutureoperation.Heshouldalso
studygeneralandlocaleconomicchangesthatwillaffectfuturebusiness.
Thisincludescompetition.
Ifthebuyerisnotqualifiedtoprepareprojectedfinancialstatements,he
shouldconsultanindependentaccountant.Thiswillinvolvesomeexpense,
butthecostwillbesmallcomparedtothelosshemightincurifheinvested
inasmallbusinesswithadoubtfulfuture.
Financialstatementsandtheiranalysisandmarketanalysisarediscussed
elsewhereinthissection.
ForecastingSales
Themostimportantprojectiontobedeterminedintheprojectedincome
statementisthesalesfigure.Afterthisnumberhasbeenestablished,the
cost,expense,andprofitfiguresareeasiertoacquire.Thedataforprojecting
saleswillcomefrompastsalesrecordsofthebusiness.Themoreaccurate
andsystematictheserecordsare,themoreconfidentlytheycanbeusedin
estimatingfuturesales.
Howlongaforecast?Abasicquestionisthis:"Overhowlongaperiodof
timeisitnecessaryorpossibletoforecastsales?"Anyforecastisuncertain,
andthefartheraforecastisprojectedintothefuture,thegreaterthe
uncertainty.Whileitmaybepossibletoexerciseatleastreasonablecontrol
overtheinternaloperation,theexternaleconomicandmarketfactorsmake
forecastingdifficultbecauseoflackofcontrol.
Perhapsthebestwaytoapproachthelengthoftheforecastisintermsofthe
expectedreturnoninvestment.Supposeitisestimatedthatthebusiness
shouldbringa20percentreturnoninitialinvestment.Theinvestment,then,
shouldbereturnedin5years.Atthispoint,theownerwouldjustbreakeven
onhisoriginalinvestment.Itseemslogicaltoprojectsalesandprofitsovera
spanoftimecomparabletothatestimatedforreturnoninvestmentinthe
aboveillustration,5years.
Anysuchforecast,however,shouldgivecarefulconsiderationtoexpected
changeseitherintheeconomyorintheindustrymarketthatmightaffectthe
patternofsaleschange.Mathematically,itispossibletoforecastsaleswith
someprecision.Realistically,however,thisprecisionisdulledbecausevital
marketandeconomicfactorscannotbecontrolled.
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Methodsofforecastingsales.Therearenumerousmethodsbywhichsales
forecastscanbemade.Mostofthemtaketheirleadfromthepastsales
performanceofthecompany.Forestablishingtrendsoraverages,5yearsof
saleshistoryisbetterthan3,and10isbetterthan5.
Perhapsthesimplestmethodistoassumethatthepercentageincrease(or
decrease)insaleswillcontinueandthatnomarketfactorswillinfluencesales
performancemoreinthefuturethaninthepast.Suppose,forexample,that
therateofyearlyaverageincreaseforthepast5yearshasbeen4percent,
andthateachyearhasshownaboutthisrateofincrease.Thenitmightbe
assumedthatsalesforthenextyearwillbe4percentgreaterthanthe
currentormostrecentyear.
Butwhatabouttheyearfollowing?Theyearafterthat?Canitbeassumed
thattheseyearswillalsoincreaseatabout4percentlevel?Eachadditional
yearintothefuturereducesthecertaintyofthepredictions.
Ifthesenegativeinfluenceslimittheaccuracytosuchanextent,whytryto
forecastbeyondtheimmediatefuture(1year)?Becausesuchaforecast
forcesthepersonmakingittogiveatleastalittleattentiontoeconomicand
marketfactorsthatmightinfluencethefutureoperationthatmight,infact,
indicatethatthepurchaseorsaleofthebusinesswouldnotbewise.
Withforecastscoveringmorethan1or2years,amoredetailedforecasting
techniqueisneeded.Suchtechniqueshouldbedesignedtoweightout
extremevariationsinyeartoyearsalesandtogiveatrendorlevelofsales
changethatismorerealisticallyorientedtoprobablefuturesalespatterns.
Nomethodofforecastingcansetanyvalueonexternalmarketconditions,
becausethereisnoguaranteethattheseconditionswillcarryoverintothe
futurewiththesamerelativesignificance.Nevertheless,theirpossible
influenceshouldbeconsidered.
RiskandReturnonInvestment
Ifabuyerwantstoinvestmoneyinabusinessthatisbeingsold,heshould
beconcernedaboutreceivingafairreturnonhisinvestment.
Manybusinessescanmakeaprofitforashorttime(1to5years)notso
manyoperateprofitablyoveralongerperiodoftime.
Fromthebuyer'spointofview,whatisafairrateofreturnfroman
investmentinasmallbusiness?Therateofreturnisusuallyrelatedtothe
riskfactorthehighertherisk,thehigherthereturnshouldbe.
Thebuyerofasmallbusinessshouldtrytodeterminetheriskfactorofthe
newbusiness,thoughthisisdifficultatbestandinmanycasesimpossible.In
attemptingtoassesstheriskfactor,thebuyershouldprojecttheprofitsof
thebusinessasfarintothefutureaspossible.Heshouldaskhimselfhow
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hightheriskshouldbenormallyandlookforconditionsthatwouldbelikely
toaffectthesalesandprofitmakingcapabilityofthebusiness.
Inanyevent,heshouldconsidercarefullytheminimumreturnoninvestment
thatheiswillingtoaccept.Thisconceptofriskisimportantinvaluingthe
businessbycapitalizationoffutureearnings.
ValuingtheBusinessbyCapitalizingFutureEarnings
Thepricetobepaidbythebuyershouldbebasedonthecapitalizedvalueof
futureearnings.Instead,however,inmostsmallbusinessbuysell
transactions,priceisbasedonthepurchaseandsaleofassets,Profitsare
madebyutilizingassets,ofcourse,butactuallytheassetspurchasedareonly
incidentaltothefutureprofitsofthenewbusiness.
Capitalizedvalueisthecapitalvaluethatwouldbringthestatedearningsata
specifiedrateofinterest.Therateusedisusuallythecurrentrateofreturn
forinvestmentsinvolvingasimilaramountofrisk.Thecapitalizedvalueis
foundbydividingtheannualprofitbythespecifiedrateofreturnexpressed
asadecimal.
Assumeforthemomentthatthefutureprofitsofabusinesshavebeen
projectedforthenext5yearsandareestimatedtoaverage$20,000ayear.
(Thisisinadditiontocompensationfortheservicesofthebuyerandany
membersofhisfamily.)Whatshouldbethesalespriceforthebuysell
transaction?
IfthisinvestmentwereassafeasGovernmentbondsthatyields6percent,
thebuyershouldbewillingtopay333,000($20,000/0.06).Ifthe
investmentisconsideredassafeasaninvestmentinanexcellentcorporate
stockthatearns10percentindividendsandpriceincreases,thebuyershould
bewillingtopay$200,000($20,000/0.10).
Veryfewsmallbusinesses,however,haveaslowariskfactorasthesetwo
investments.Whatrate,then,shouldbeusedincapitalizingtheearningsofa
smallbusiness?Usually,20to25percentisconsideredadequate.Thismeans
thatthebuyershouldpaybetween$80,000and$100,000forthisbusiness.
Ifitearnstheprojected$20,000ayear,thebuyerwillrecoverhisinitial
investmentin4or5years.Thistimewillbeextendedbyincometaxestobe
paidontheincome,butthiswouldalsobethecaseformostalternative
investmentsexceptnontaxablesecurities.
Inusingacomputationsuchasthis,theimportanceoflongrunprofitsshould
bekeptinmind.Unlessprofitsarepossibleoveralongperiodoftime(10to
15years),investmentinasmallbusinessmaybeapoordecision.Thetrend
ofprofitsisalsoimportant.Ifallotherfactorsarethesame,acompany
whoseprofitsaredecliningisworthlessthanonewhoseprofitsare
increasing.
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ValuingtheBusinessontheBasisofAssetAppraisal
Themajorityofbuyselltransactionsarebasedonavalueestablishedforthe
assetsofthecompany.Thisapproachisnotrecommended,butifitistobe
used,thesuggestionsthatfollowshouldbeconsidered.Amostimportant
pointistofindoutearlyinthetransactionjustwhatassetsaretobe
transferred.Usually,thesellerhassomepersonalitemsthathedoesnotwish
tosell.Prepaidinsurance,somesuppliesandthelike,inadditiontocash,
marketablesecurities,accountsreceivable,andnotesreceivableusuallyare
notsold.Ifthebuyerdoespurchasethereceivables,thesellermay
guaranteetheircollection,butsuchaguaranteeshouldbeestablished.
Theassetsmostcommonlypurchasedinasmallbusinessbuyselltransaction
aremerchandiseinventory,salesandofficesupplies,fixturesandequipment,
andgoodwill.
Evaluatinggoodwill.Oneoftheassetsthatmustbeconsideredinabuy
selltransactionisgoodwill.Goodwill,inageneralsense,arisesfromallthe
specialadvantagesconnectedwithagoingconcernsgoodname,capablestaff
andpersonnel,highfinancialstanding,reputationforsuperiorproductsand
customerservices,andfavorablelocation.
Fromtheaccountingpointofview,goodwillistheabilityofabusinessto
realizeabovenormalprofitsasaresultofthesefactors.Byabovenormal
profitismeantahigherrateofreturnontheinvestmentthanthatordinarily
necessarytoattractinvestorstothattypeofbusiness.Thevalueofgoodwill
canbecomputedineitherofthefollowingways:
1.Capitalizationofaveragenetearnings.Asexplainedabove,the
amounttobepaidforabusinessmaybedeterminedbycapitalizingexpected
futureearningsataratethatrepresentstherequiredreturnoninvestment.
Thedifferencebetweenthisamountandtheappraisedvalueofthephysical
assetsmaybeconsideredthepriceofgoodwill.
Thismethodusesonlyearningsincomputingthepricetobepaidforthe
business,Forthatpartofthecalculation,itignorestheappraisedvalueofthe
assets.
2.Capitalizationofaverageexcessearnings.Thismethodrecognizes
bothearningsandassetcontributions.Itstartswiththeappraisedvalueof
theassetsandcomputeswhatwouldbeafairreturnonthatvalue.Ifthe
estimatedfutureearningsarehigherthanthis"fairreturn,"thedifference
betweenthetwofiguresthe"excessearnings"iscapitalizedatahigher
rate,andtheamountthusobtainedisconsideredthegoodwillvalue.This
figureisaddedtotheappraisedvalueoftheassetstogiveapriceforthe
business.
Paymentofexcessearningsisoftenstatedintermsof"yearsofpurchase"
insteadofintermsofcapitalizationatacertaininterestrate.Capitalizationof
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averageearningsat20percentisthesameaspaymentfor5years'excess
earnings.
Astheabovediscussionshows,thedeterminationofgoodwillusuallyreflects
thevalueofprofitsthatwillberealizedbythebuyerabovethenormalrateof
returnthatis,theexcessprofits.Butmostsmallbusinessesthatareforsale
donothaveexcessprofits.Theyusuallyshownominalprofitornoneatall.
Oftenthesellermakesanofferthatseemsquitegood,butthebuyermustbe
abletoeliminatetheseller'semotionsandreduceallfactstoworkable
relationships.
Ifthereareexcessprofits,goodwillisusuallyvaluedbycapitalizingthemata
fixedpercentageestablishedbybargainingbetweenthesellerandthebuyer.
Thecapitalizationpercentageneedstobehighbecauseprofitshigherthana
normalreturnaredifficulttomaintain.Excessprofitsof$4,000capitalizedat
10percentwillgiveagoodwillvalueof$40,000($4,000/0.10).
Capitalizingthesameexcessprofitsat20percentgivesagoodwillvalueof
$20,000($4,000/0.20).
Thoughgoodwillvaluationisthefirstassetvaluationtobediscussedhere,it
isnormallythelasttobecomputed.Sincefewsmallbusinessesbeingsold
areproducingexcessprofits,theproblemofgoodwillvalueisnotapressing
oneinmostbuyselltransactions.
Merchandiseinventory.Inaservicebusiness,placingavalueonthe
inventoriesisaminorproblembutindistributiveandmanufacturing
businesses,theinventoryislikelytobethelargestsingleasset.A
manufacturer,forexample,hasthreeinventoriesrawmaterial,workin
process,andfinishedgoodsandeachofthempresentsdifferentproblemsin
valuation.Thedistributivecompanyhasonlyoneinventory,called
merchandiseinventory.
Thefinancialstatementspresentedbythesellerwillprobablyreflectan
inventoryvaluedifferentfromtheoneassignedinabuyselltransaction.
Inventoriesareusuallycarriedonthebookseitheratcostoratthelowerof
costormarket.Marketisdefinedasthecurrentreplacementcosttothe
seller.
Indeterminingthevalueofinventories,thesellerhastochoseamethodof
arrivingatcost.Themostcommoncostingmethodsarefirstinfirstout
(FIFO),lastinfirstout(LIFO),andaveragecost.Thesemethodsmaygive
verydifferentvaluesandthebuyerandsellermustarriveatsomevalue
agreeabletoboth.Themostcommonmethodsusedinvaluinginventoriesfor
buyingandsellingsmallbusinessesarecostoflastpurchaseandcurrent
marketprice.
Thequantityoftheinventoryisusuallydeterminedbyaphysicalcount.The
physicalinventoryproceduresshouldbedecidedbeforethecount,andeach
inventoryteamshouldincludeonerepresentativefromthebuyerandone
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fromtheseller.Itiseasytoomititemsfromtheinventorycount,andhere
thesellerisusuallyinamorevulnerablepositionthanthebuyer.Thereis
moredangerofomittingitemsfromthecountthanofdoublecountingthem.
Itmaybethatsomeitemsofinventoryarenottobesold.Ifso,theseitems
shouldbesegregatedbeforethecountbegins.Anotherproblemis
determiningwhatqualityofitemsaretobeincludedintheinventory.The
buyerneedstobecautiouswhenexaminingtheinventoriesinmostbuysell
situationsthereissomeinventorythatisnotsalable.Thisisonereasonwhy
thebuyershouldemployashisrepresentativesontheinventoryteam
individualswhoareacquaintedwiththattypeofinventory.Ifthebuyerand
thesellerdisagreeonthevalueofcertainitems,thesellerwillremovethese
itemsfromthelistofinventoryforsale.
Whentheinventoryisbeingpriced,beverycarefulinmatchingpriceto
quantity.Besurethattheunitsinwhichthequantityisrecordedandthe
unitspricedarethesame.Thephysicalcountshouldberecordedinduplicate
sothatbuyerandsellercaneachmakeseparateextensionsafterallprices
havebeenlisted.Afterindependentextensions,thetwoinventoriesshouldbe
reconciled.
Manufacturer'sinventory.Whenamanufacturingcompanyisbeing
exchanged,therawmaterialsinventoryistakenandpricedlikethe
merchandiseinventoryofadistributivebusiness.Theworkinprogressand
finishedgoodsinventoriesmaypresentaproblem.Usually,thereisno
marketpriceorcostoflastpurchasetorelatetotheseinventories
consequently,theseller'scostisgenerallyusedforestablishingprices.
Ifthesellerhasunusedplantcapacityorifhisplantisinefficient,hiscosts
maybeinflated.Suchasituationrequiresthehelpofanaccountantwitha
goodknowledgeofcostaccounting.
Storesuppliesandofficesupplies.Thesetwoitemsareusuallyquite
small.Theyshouldpresentnoproblem,thoughsomeofthemmayhaveno
valuetothebuyerifthenameofthecompanyistobechanged.Afterthe
usablesupplieshavebeendetermined,aphysicalinventoryshouldbetaken
andpricedasinthecaseofthemerchandiseinventory.
Propertyassetsandaccumulateddepreciation.Thepropertyasset
accountnormallyreflectsthecostoftheassetsreducedbyaprovisionfor
depreciation.Inmanysmallbusinessbuyselltransactions,norealpropertyis
exchanged,becausetheplantsiteisleased.Theproblemofestablishinga
valueonrealestateisnotasacute,anyway,sincethemarketvalueforreal
propertydoesnotfluctuateaswidelyasthemarketvalueforpersonal
property,Itiscustomarytohaveanindependentappraiserestablishavalue
forrealproperty.Appraisers'findingsonrealpropertyareusuallymore
acceptabletobothpartiesthanpersonalpropertyappraisalsthereal
propertymayhavemultipleuses,whereaspersonalpropertyconsistsof
singlepurposeassets.Thebookvalueofrealpropertywillbeclosetothe
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appraisalvalueunlessthepropertyhasbeenheldforalongperiodoftimeor
unusualcircumstanceshavecausedsuddenanddrasticchangesofreal
propertyvalues.
Personalpropertyassets.Thebuyermayfeelthatheknowsgoingvalues
ofthepersonalpropertyanddecidenottoretainanindependentappraiser.
Inaddition,manyindividualsbelievethatcostorbookvalueisagoodplace
tobeginnegotiationsforpersonalproperty.However,becauseofthemany
methodsofcomputingdepreciationandalsobecauseofconflictingideas
aboutcapitalizingcosts,thecostorbookvaluemaynotreflectavaluethatis
agreeabletobothparties.
Itisdifficulttoassignavaluetopersonalpropertyequipmentbecausethese
assetshavelittlevalueifthecompanyisliquidated.Therefore,agoing
concernvalueshouldbedetermined.Thepricetobepaidforthisequipment
shouldbesomewherewithintherangeofthecostofnewequipmentorthe
costofcomparableusedequipment.Forthisreason,anindependent
appraisercanbeuseful,particularlyifheisacquaintedwiththetypeof
equipmentbeingsoughtorsold.
Thesellershouldrealizethathemayownassetsthatdonotappearonthe
fixedassetschedule.Manycompanieshaveapolicyofnotcapitalizingany
assetsbelowsomearbitraryamount($200or$300).Acompletephysical
inventoryshouldbetaken.
Iftheassetsarenumerousandgeographicallydispersed,thesellermaybe
askedtoprepareacertifiedlistoftheassetsgivingdescriptionandlocation.
Thebuyercanthentestthelistbyverifyingonlyselectedassetsatthetime
ofthesale,butwithplanstoverifyallofthemwithinacertainperiodoftime.
Thevalueofpersonalpropertyassetsisusuallydecidedafterconsiderable
bargaining.Itisbettertoassignvaluestoindividualassetsratherthanto
makealumpsumpurchaseofassets.Inalumpsumpurchase,thereismore
chanceofoverlookingsomeassetvalues.
Thebuyershouldtrytodeterminetheconditionoftheassetsaswellasrepair
andreplacementrequirements.Ifhedoesn'testablishtheconditionofthe
assetsindividually,repairandpossiblereplacementcostsmaycreatean
unexpectedlyheavydrainonhisworkingcapital.
IncomeTaxConsequences
Incometaxconsequencesofthebuyselltransactionmaybeanimportant
bargainingissueifthebuyerandsellerareawareofthem.Thesellershould
beconcernedabouttheamountoftaxhewillhavetopayonhisgainsfrom
thesale.Thebuyershouldbeconcernedaboutthetaxbasishewillacquireas
aresultofthetransaction.Theseconcernsalmostinevitablyleadthebuyer
andsellerintoconflictinvaluingthebusiness.
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Theincometaxlawsarehighlytechnical,andthepossiblevariationsina
buysellsituationareinfinite.Becauseofthis,adiscussionspecificenoughto
bereallyhelpfulisimpossiblehere.Bothbuyerandsellershouldstudythe
applicabletaxlawsandifanimportantdecisioninthebuysellagreementis
tobebasedonincometaxconsequences,theadviceofanincometaxexpert
shouldbesought.Thekeytotaxsavingsistaxplanningbeforethebuysell
contractisclosed.
Thesellershouldkeepinmindthathemustreportanyincometaxliabilityhe
incursbysellingagoingbusiness.Reinvestingthesalesproceedsinanother
businesswillnotenablehimtoavoidorpostponeshisincometaxliability.
AValuationExampletheRegalMen'sStore
Thisexamplewillhelptobringthefactorsdiscussedaboutintobetterfocus.
Itisnotintendedtoshowwhatshouldbedonebuttogivesomeideaofwhat
mightbedone.
Thebuyerandtheseller.JoeCritserisinterestedinbuyingamen's
clothingstore.Hehashadnearly25years'experienceinthemen'sclothing
tradefirstasasalesmaninretailstoresandmorerecentlyasasales
representativeforSentinel,amajormanufacturerofmen'sclothing.Now45
yearsold,Critserisinterestedinhavingastoreofhisown.
InFebruary,CritserlearnsthattheRegalMen'sStoreisforsale.James
Rombaugh,ownerandoperatorofthestore,isnow67andwantstoretire,
hesays.Hehasnoheirs,andnoemployeeofthestoreisfinanciallyableto
purchasethebusiness.Rombaughstartedthestoreinthelatesixtiesandhas
beenthesoleownersincethan.
Thestore.Critser'searlyinvestigationconvinceshimthatthestorehasthe
kindofpossibilitiesheislookingfor.Althoughithasbeenoperated
conservatively,ithasagoodreputationinthecommunityandacreditable
standingintheclothingtrade.Thestorehasneverbeenparticularly
aggressiveinadvertising,theownerhasreliedonrepeatpatronageand
wordofmouthadvertising.
CritsersuspectsthatpartofRombaugh'sdesiretosellisduetocompetitive
pressurefrommoreaggressivestoresinthecommunity.Saleshave
continuedtoincreaseaboutinproportiontothemarketingeneral,butgross
marginandprofithavebeenreducedbecauseofloweroverallmaintained
markupandincreasingcostsofoperation.Rombaughownstheinventory,
fixturesequipment,andoperatingsuppliesandleasesthebuildingat5
percentofnetsales,withaminimumpaymentof$1,000amonth.The
currentleasewillexpireinabout4years.
Thepreliminarydiscussion.Rombaughhasbeenwellimpressedwith
Critserandagreestofurnishnecessaryfinancialinformation.Intheir
discussiontodate,Rombaughhasstatedthathefeelsthebusinessisworth
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about$100,000forthepurchaseofinventory,fixtures,equipment,and
goodwill.Hewillretainallaccountsreceivable,butheiswillingtoallowthe
newowneran8percentfeeforoutstandingaccountsreceivablecollected
afterthetransferofownershiphasbeencompleted.
Healsowantstokeepafewassetsforwhichhehasasentimental
attachment,suchasamassiverolltopdeskpurchasedwhenthestorewas
firstopened.Rombaughwillassumeresponsibilityforpaymentofliabilities
outstandingatthetimeofsale.
Critser,ontheotherhand,feelsthatthebusinessisworthsomewhatless
than$100,000.Itisobvioustohimthroughcasualinspectionthatsomeof
theinventoryisworthlessthantheoriginalpurchaseprice,andhedoubts
thevaluethatRombaughwouldplaceongoodwill.Healsonotesthatsomeof
thedisplayequipmentisoutmodedandneedsreplacement.
BeforeacceptingorrejectingRombaugh'sprice,Critsersuggeststhathebe
permittedtomakehisownevaluationofthebusinessonthebasisofpast
financialrecordsandanappraisaloftheassets.Rombaughagrees.Following
arethemajorelementsofCritser'sinvestigationandappraisal:
Pastsales
XXX1$220,000
XXX2228,800
XXX3238,000
XXX4247,600
XXX5257,600
ForecastsalesXXX6
$265,000Critser'sestimateofsales,whichincludesasomewhatsmaller
increasethantheaverageof3.2percentperyearbetweenXXX1andXXX5.
$268,676Rombaugh'sestimatebasedontheaverage.
Fiveyearoperatingstatement
XXX1XXX2XXX3XXX4XXX5
Sales$220,000$228,800$238,000$247,600$257,600
Costofgoodssold139,980146,432159,260160,940167,440
________________________________________
Grossmargin80,02082,36878,74086,66090,160
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Operatingexpenses*62,42066,35262,67470,56674,704
________________________________________
Profit17,60016,01616,06616,09415,456
*Includesowner'ssalary.
ProjectedoperatingstatementforXXX6
CRITSERROMBAUGH
(Buyer)(Seller)
Sales$265,000$268,676
Costofgoodssold172,250174,640
________________
Grossmargin92,75094,036
Operatingexpenses*76,85075,766
________________
Profit15,90018,270
*Includesestimateofowner'ssalary.

BalancesheetofRegalMen'sStoreasofJanuary31,XXX6
Assets
Cashonhandandinbank$20,000
Accountsreceivable$32,000
Lessestimateduncollectible4,000
________
28,000
Merchandiseinventory49,214
Salesandofficesupplies1,920
Fixtures20,000
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Lessestimateddepreciation5,600
________
14,400
Equipment19,000
Lessestimateddepreciation8,600
________
10,400
Miscellaneousassets1,280
________
Totalassets$125,214
Liabilities
Accountspayable$11,000
Payrollandsalestaxpayable1,300
_______
Totalliabilities$12,300
JamesRombaugh,capital112,914
Networth
________
Totalliabilitiesandnetworth$125,214
Salableassets
Inventoryatcurrentbookvalue$49,214
Salesandofficesupplies1,920
Fixtures,currentdepreciatedvalue14,400
Equipment,currentdepreciatedvalue10,400
________
Totalsalableassets$75,934
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Valuationofinventoryandappraisaloffixedassets
CRITSERROMBAUGH
Inventorybyphysicalcount$47,514
90percentvaluedatcurrentprices$42,762
5percentvaluedat75percentofcurrentprices1,782
5percentvaluedat50percentofcurrentprices1,188
________________
Inventoryappraisedvalue45,73247,514
Usableofficesupplies1,6801,680
Fixturesappraisedvalue13,60013,600
Equipmentappraisedvalue*9,4009,400
________________
Totalassetsappraisedvalue$70,412$72,194
*Independentappraiser.ExcludesassetstoberetainedbyRombaugh.
Howmuchtopay?
IfCritserfeelsthathisreturnoninvestmentshouldbecapitalizedover5
years,hisofferingprice,basedonanticipatedprofitsfortheyearahead,
wouldbe$79,500(5years=20percentperyear$15,900/0.20=$79,500).
If,ontheotherhand,thepurchasewasbasedontheappraisedvalueof
assetsonly,thepurchasepricewouldbe$70,412plusanyprovisionfor
goodwill.
Sincebothofthesefiguresarewellbelowthesuggestedpriceof$100,000,
negotiationwillbenecessary.Herearesomequestionsthatmightarise:
1.Inlightoffuturesalesandprofitpossibilities,aretheassetsworthmore
thanthesaleprice?
2.IstherisklessthanCritseranticipates?Topay$100,000,hewouldhave
toreducehisriskleveltobetween6and7years.
3.IsRombaugh'spricetoohighinthelightoffuturesalesandprofit
possibilitiesundernewmanagement?
4.HowmuchconfidencedoesCritserhaveinhisabilitytorealizean
acceptablereturnonhisinvestment?
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5.Istheactualvalueofthisbusinessasagoingconcerncloserto$68,000,
$80,000,or$100,000?
6.HowmuchisthegoodwillofthisbusinessactuallyworthtoRombaugh?To
Critser?
7.Whatkindofcompromisemightbesatisfactorytoboththebuyerandthe
seller?
OtherTopicsinthe'BuyingandSellingaBusiness'Section

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