Masonry Magazine March 2001 Page. 39
Valuing a Masonry Contracting Operation
One of the most difficult tasks facing any masonry contractor is placing a value on his or her business. How much is it worth? What is the value of the "goodwill" that has been built up over the years? How much would a buyer be willing to pay for the business?
There are several methods that can be used to value a masonry contracting operation. One method is to simply take the book value of the business. This is the value of the assets of the business, less the liabilities. However, this method does not take into account the "goodwill" of the business.
Another method is to use a multiple of gross income. This method takes the gross income of the business and multiplies it by a factor. The factor will vary depending on the size and profitability of the business.
A third method is to use a capitalization of earnings approach. This method takes the net profit of the business and divides it by a capitalization rate. The capitalization rate will vary depending on the risk of the business.
No matter which method is used, it is important to remember that the value of a masonry contracting operation is ultimately what a buyer is willing to pay for it.
There are several factors that can affect the value of a masonry contracting operation. These factors include:
* The size of the business
* The profitability of the business
* The location of the business
* The reputation of the business
* The management of the business
* The condition of the equipment
* The amount of competition
* The overall economy
It is important to consider all of these factors when valuing a masonry contracting operation.
One of the most important factors to consider when valuing a masonry contracting operation is the "goodwill" of the business. Goodwill is the value of the business over and above the value of its tangible assets. Goodwill can be created by a number of factors, including:
* The reputation of the business
* The location of the business
* The management of the business
* The customer relationships of the business
* The brand name of the business
Goodwill is an intangible asset, but it can be a very valuable asset. In some cases, the goodwill of a business can be worth more than the tangible assets of the business.
When valuing a masonry contracting operation, it is important to consider the goodwill of the business. There are several methods that can be used to value goodwill. One method is to use a multiple of earnings. This method takes the earnings of the business and multiplies it by a factor. The factor will vary depending on the size and profitability of the business.
Another method is to use a discounted cash flow analysis. This method projects the future cash flows of the business and discounts them back to the present value. The present value of the cash flows is the value of the goodwill.
No matter which method is used, it is important to remember that the value of goodwill is ultimately what a buyer is willing to pay for it.
Valuing Goodwill
How do you value the goodwill of a masonry contracting operation?
One method is to consider the owner's salary, retirement plan contributions, and other "perks." How extravagant are the owner's and/or the manager's "perks"? How lavish or plush are the masonry operation's business premises?
One appraiser of businesses in general, not only masonry operations, relies on an alternate "bottom line" valuation method such as that mentioned earlier. It is, quite simply, five times the net profit of the business - first adding back the owner's salary and retirement plan contributions and before income taxes. This method could best be compared with "capitalizing" the earnings of the business at 20 percent (five years) in order to determine the value of the operation's goodwill. The "five times" figure is not a figure that is chiseled in stone; it could be four, six or three, but the concept remains the same.
Often this valuation method will produce a value quite similar to the gross income valuation method. Many masonry contracting operations in the $500,000 income range, for example, produce about $100,000 "net" which the owner takes as compensation and (usually) retirement plan contributions or other "perks." In a situation such as this, either valuation will produce a $500,000 goodwill valuation.
One year's gross income... $500,000
Five times the "net" before owner's total compensation (5 x $100,000). $500,000
Frequently, not always, the two valuation methods produce a very similar valuation figure for goodwill.
"What these accountants and "experts" don't seem to realize is that in a masonry business, the bottom line" can be varied by the owner - virtually at will."
As already pointed out, there may be differences of opinion regarding the book value of any business. Those differences, for the most part, are easily resolved because they involve real or "tangible" assets. Intangible assets, particularly "goodwill" are usually more difficult to place a value on.
The commercial advantage of any business, due to its established popularity, reputation, patronage, advertising, location, etc., over and beyond its tangible assets is one definition of goodwill. In the sale of a business, the amount over and beyond the value of the hard or tangible assets that is paid represents profit to the seller. The buyer accounts for that figure by labeling it as goodwill (and writing it off over a 15-year period).
Unfortunately, a going business does not enjoy a similar write-off for the goodwill the business has accumulated over the years since its formation. Reflected in the operation's books or not, that goodwill is there. The questions is: how big role will it play in the valuation equation?
Obviously, every contractor must first decide why they want to establish a value for their masonry operation. With this question answered, it can be decided whether a low or a high value is desired. A low value could merely be the book value taken directly from the operation's financial statements or income tax returns. A high value can take into consideration all of the intangible assets such as goodwill that are not reflected on the masonry operation's books.
The bottom line question in the valuation puzzle, however, always remains the same: what is the purpose of this valuation?
Mark E. Battersby is a tax and financial advisor, freelance writer and columnist.
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MASONRY MARCH, 2001 39