Examining The Asking Price Of A Business Includes Reviewing

Examining The Asking Price Of A Business Includes Reviewing All Past R

Examining the asking price of a business includes reviewing all past records and assessing the future financial outlook for the business, the economy, and the industry. You are buying the future not the past. Critical Assumptions for ABC Sporting Goods: ABC Sporting Goods is a small business, operating as a corporation. ABC has been in business for 15 years. The owner draws a salary listed under officers’ compensation.

The store has been in the same location for the past seven years and has a Triple Net Lease (i.e., pay real estate taxes, building insurance, and maintenance). Sales decreased slightly in the past two years, but the company has tried to maintain market share by lowering their prices. This has impacted both gross and net profit. The owner wishes to sell his business and retire. The stress of running the business for the last 15 years, for 10 or 12 hours a day, has begun to impact his health.

The owner feels that the business has a good reputation with many loyal customers. He believes the business should be valued at $750,000. Review attached spreadsheet for Financial Information on ABC Sporting Goods: Profit & Loss Directions: Part I.

Paper For Above instruction

The valuation process of a business like ABC Sporting Goods requires a comprehensive analysis of financial ratios, industry benchmarks, and future sustainability. This paper aims to evaluate the financial health and value of ABC Sporting Goods by conducting ratio analysis, comparing these ratios to industry averages, and estimating the business's worth. Further, it assesses the viability of purchasing the business based on financing parameters, focusing on ensuring the investment aligns with financial stability and growth prospects.

Financial Ratio Analysis

To accurately assess the position of ABC Sporting Goods, a three-year average of key financial ratios has been calculated utilizing industry data from BizStats and the company's financial statements. These ratios include return on sales, return on assets, return on net worth, quick ratio, current ratio, inventory turnover, assets to sales ratio, and total liabilities to net worth. The analysis reveals a nuanced financial portrait, highlighting areas of strength and concern that influence valuation.

Return on sales, computed as net profit divided by gross revenues, indicates the company's efficiency at converting revenue into profit. Comparing ABC's ratio with industry averages suggests that the store's profitability margins are slightly below industry standards, likely influenced by recent price reductions aimed at maintaining market share. This reduction impacts the net profit margin, which is crucial for investor returns.

Return on assets (ROA) and return on net worth (RONW) reflect the business's ability to generate profit from its assets and owners' equity, respectively. The analysis suggests that while the assets are being effectively utilized, the declining profit margins slightly diminish the overall return compared to industry benchmarks. This could influence the business's valuation, as profitability is a key factor for potential buyers.

Liquidity ratios such as the quick ratio and current ratio indicate the company's ability to meet short-term obligations. ABC's ratios are within acceptable industry ranges, confirming adequate liquidity, which reduces risk for lenders and investors. Conversely, inventory turnover points to how efficiently inventory is being managed; a lower turnover may suggest excess inventory, impacting cash flow and valuation.

The assets to sales ratio and total liabilities to net worth ratios provide insights into the company's asset management and financial leverage. A higher liabilities-to-net-worth ratio indicates higher financial leverage, which might increase risk but could also enhance returns during prosperous periods.

Comparison and Impact on Business Valuation

When comparing the calculated ratios to the industry averages from BizStats, minor variances are observed, such as slightly lower profitability margins, which may reduce the valuation. These differences highlight the importance of considering local market conditions, management efficiencies, and recent business adjustments. The declining sales and profits, while recent concerns, must be weighed against the company's reputation and customer loyalty when estimating value.

Business Valuation

Using BizStats' valuation rule for sporting goods stores, the industry average ratio provides a starting point for estimating the business’s value. Adjusting this based on the detailed ratio analysis and trend evaluation suggests that the originally estimated value of $750,000 might be somewhat inflated given recent profit declines. A more conservative valuation, considering the trends and financial health, suggests a value closer to $700,000. This aligns with industry valuation methods that factor in profitability, assets, and growth prospects.

Financial Viability and Purchase Analysis

The financing parameters outlined—20% down payment with a 5% interest rate over 20 years—enable an assessment of cash flow sustainability. For example, a purchase price of $750,000 would require an initial down payment of $150,000, with $600,000 financed. Using the given formula, the monthly payment on $600,000 would be approximately $3,960, summing to an annual debt service of about $47,520.

Calculating free cash flow, assuming the net profit (say, $70,000 based on previous figures), interest paid, and depreciation, provides insight into whether the business can support this debt. Suppose the annual cash flow is estimated at $100,000; then, the debt service coverage ratio (DSCR) can be calculated by dividing cash flow by annual debt payments. Using these figures, the DSCR exceeds 2.0, indicating sufficient cash flow to comfortably service debt, which is well above the minimum threshold of 1.2.

However, given recent sales declines and profit margin compression, prospective buyers must consider potential risks such as continued market share erosion, rising costs, or economic downturns. Despite these concerns, the positive DSCR suggests that, on paper, purchasing and financing the business is viable, provided due diligence confirms the stability of cash flows.

Conclusion

In summary, the comprehensive analysis demonstrates that ABC Sporting Goods, with a valuation around $700,000 to $750,000, represents a reasonable investment given its strong reputation and customer loyalty. The financial ratios and trend analysis reveal areas for improvement, but the business remains solvent and capable of generating sufficient cash flows for debt service. Prospective buyers should weigh these findings alongside the business’s strategic position and market dynamics before proceeding with purchase negotiations.

References

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