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RUNNING YOUR BUSINESS AS IF YOU COULD SELL IT TOMORROW: PART 1

In this two-part series, Andrew Usher, director of Catand Advisory, gives some helpful advice on how to brush up your finances and streamline your operations in the event of selling your business.

What if you were approached by someone saying, “I will pay you top dollar for your business, providing you can demonstrate the true value of your business.” Could you pull that information together easily?

Somewhere along the line we all think about retirement or selling our businesses (for the right price). All businesses should be run as though someone could walk in at any time and be presented with the facts about the true value of the business.

What then does ‘true value’ mean to an acquirer? This doesn’t just mean the figures relating to finances and underlying profit but also the value in how the business operates, including IT systems, procedure manuals, training material, people and culture. There’s also the question of whether this value will hold once you have exited the business.

Here in part one of this article we will look at the financial aspects.

Accounting records

Are your accounting records in good order? A typical small-to-medium enterprise (SME) will run in a very tax-effective accounting manner whereby personal expenses such as running a vehicle and trips away may be run through the business.

There are instances where the books are meticulously kept, however even these pest management businesses may not have set up their books in a manner whereby they can be benchmarked against other pest businesses or industry averages (more on this below).

In this regard, taking simple steps to ensure certain costs are compartmentalised provides a prospective acquirer with a very clear understanding of these costs, which they can then benchmark against their own business or others in the industry. Figure 1 is a simple overview of how the finances should be structured. Looking at your books, would an acquirer be able to follow the financial flow from sales and revenue through to profit? The answer should of course be yes.

Sales/Revenue Invoiced income excluding GST
Cost of Sales

Includes all costs to deliver the service: technician wages, chemical and equipment costs, technician vehicle costs

Gross Profit (Sales less Cost of Sales)
Expenses All other expenses, excluding personal costs
Operating Profit (Gross Profit less Expenses)
Depreciation Only on true business assets

Earnings Before Interest and Taxation (EBITA)

Interest is ignored because typically debt will not transfer to an acquirer

Taxation is also ignored as each business has differing tax implications

Figure 1: Example financial structure

Three key areas of expenses to compartmentalise are payroll, personal costs and synergies.

Payroll

If we were to look at payroll, do you categorise the wages you pay according to role, such as technicians, administration, accounting, sales, management and directors/owners? Technicians are directly related to production, i.e. income generation and would be deemed a ‘cost of sale’ expense, so should be categorised separately. Wage cost as a percentage of revenue is an important indicator for an acquirer to determine how productive or efficient your business is and technicians are.

Excluding personal and one-off costs

Are personal or non-business costs clearly identified within your accounting system? There are many ways to clearly earmark these costs in modern accounting systems to enable an acquirer to easily identify and exclude them. For instance, in MYOB, an owner could use the Jobs function to assign a job code to an expense item that is personal. This means that they could easily run a report based on that job code for all costs assigned to it. The same could be done for the write o of low value assets, which in a larger corporation would be a capital expense i.e. not a profit and loss expense.

Synergies

Costs that an acquirer may not need to bear going forward, and therefore disappear on acquisition are known as ‘synergies’. It is one of the benefits of acquiring a business – you expect there to be synergies to make the combined or merged businesses more profitable. Identifying potential synergies such as accounting functions or director/owner wages are equally important to identify and compartmentalise, as this reveals the true underlying profit of the business.

Benchmarking

Do you benchmark your business against industry standards? The ATO provides benchmarks for pest control businesses. For a business with revenue over $400,000, the ATO outlines the following:

Benchmark Ratio % of Revenue (excl GST) Average % of Revenue (excl GST)

Cost of Sales/Turnover

10-18% Average: 14%
Labour/Turnover 26-38% Average: 32%
Motor Vehicle Expenses/Turnover 4-6% Average: 5%

Using the ATO’s benchmarks, you would calculate that a typical pest control business with revenue in excess of $400k would have a gross profit of 49% on average. This gross pro t is calculated by adding the average percentages of revenue (14% + 32% + 5%) and deducting that sum (51%) from 100%. From industry knowledge and experience, I would state that this is quite low and that the average should be between 53-55% or slightly higher.

When it comes to benchmarking, pest managers in the US have done it right. In 2015, the National Pest Management Association in the US ran a benchmarking exercise across nearly 9,000 pest management businesses to determine a number of averages across the pest industry including revenue growth, profitability and profit improvement, expenses as a percentage of revenue, the pests that are driving business growth, and employee costs as a percentage of revenue to name a few.

The sharing of this information across the US enables SME pest organisations to benchmark themselves and challenge or share key financial statistics for the betterment of the industry. It is my belief that the Australian pest industry would benefit from a similar exercise. Until this happens, Figure 2 below provides some key industry averages to benchmark yourself against based on my own knowledge and experience.

Organic Revenue Growth

~4% growth from new customers, price increases and increasing scope of services

(Ibisworld states that the industry is growing at 4.6% per annum)

Gross Profit Percentage
(Sales less Costs of sales)/Sales x 100

52% and above using the definition of Cost of Sales as provided in Figure 1

Earnings Before Interest and Taxation (EBITA)

20% and above using the definition of EBITA as provided in Figure 1 and typically excluding directors’ fees

Revenue Per Technician Per Day

$1,000-$1,500 per day and above excluding GST (calculated on a weekly or even monthly basis as you will have high and lower days)

Figure 2: Industry benchmark averages

Part two of this article, which will appear in the Feb/Mar issue, will look at people and culture, asking the question of whether your business could continue to be successful without you if it were sold tomorrow.

Andrew Usher, Director, Catand Advisory

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