The last method of valuing a business is the extra earning potential, or super profits method. To do this, calculate the income that would be earned from investing an amount equivalent to the asset worth of the company, its fixtures, fittings, machinery and stock, in the bank. Add to it an annual salary for managing the business, then deduct it from the net profit of the business over 12 months. This is called the extra earning / super profit of the business. Multiply that figure by a factor, in years, to determine the goodwill and add the result to the asset value and you get a value for the business.

Example:
Extra Earning potential / Super Profits
Garden Service

With assets of R60 000, the equivalent percentage amount on fixed deposit at 11% would earn R6 600 a year. Add a R36 000 annual salary = R42 600. Deduct R42 600 from the annual net profit of R72 000 to give an extra earning potential of R29 400 a year. Using the one year period of the payback method detailed previously gives a goodwill value of R29 400 ( R29 400 x 1 ). Add this to the R60 000 asset value to give a price valuation for the garden service business of R89 400.

Gift Shop

Asset value = R140 000. Earning 11% pa = R15 400 return + salary of R36 000 pa = R51 400. Multiplied by 1,5 years = R77 100 + assets of R140 000 = a price valuation of R217 100. This method puts a higher price on a business with a higher asset base. This may not always be justified.

Market Value

To balance out anomalies, take an average of results of the three methods I have detailed. For the garden service, that works out at R72 000 + R80 000 + R89 400 for an average of R80 466. For the gift shop, R108 000 + R90 000 + R217 100 = R138 366 average. The R57 900 variation between two businesses with the same net profit is justified by the differences in risk profile and asset base.

Although the price of the gift shop is only its stock value, remember assets are only as good as the profits they generate and also each business with similar profits is in competition for the same buyers.

But why, you ask pay a premium of R52 000 plus to achieve a very similar profit level? Simple. Not everyone wants a garden service business some and would rather pay the extra for a venture with less risk, fewer labour problems, a bigger asset base and maybe most importantly one they can empathise with.

Mike Hindle of Aldes Business Brokers, www.aldes.co.za

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