Do you ever remind yourself of why you’re in business? It’s very easy to get caught up in the daily problems and hassles of running a business but sometimes you need to step back and take a look at what it is you are trying to achieve.
Is your business helping you to attain your future wealth and retirement requirements or is it just providing you with a job?
Sometimes your success will come down to demanding more from your business and, consequently, more for yourself. It requires an understanding of the “gap” that exists between what we want the business to achieve and what it is currently achieving. This is known as GAP analysis.
Before we look at the “gap” it should be recognised that when business owners begin thinking about retirement and/or selling, most would like to exit the business almost as soon as they decide to sell. There is a mental change, once the decision is made, that makes it difficult to continue giving 100 per cent to the cause.
It often doesn’t take long from the moment the decision is made to start seeing a decline in sales and performance in a business. This is something you need to avoid and it’s all the more reason why a GAP analysis should be done sooner rather than later.
Your retail business might be many things to you but it is mostly a tool to help achieve your current and future living and wealth needs and should be viewed accordingly. Your market income reflects your daily activity and therefore should not be considered a return on investment, which should come over and above your market income each year.
It might also be hard to substantiate goodwill to a potential purchaser if a business cannot post a surplus after all wages are paid, including the owners’ own salaries.
Otherwise referred to as the “bottom up” budget, there are four steps to the GAP process. These include the gross profit GAP, the sales GAP, the stock GAP and the GAP analysis, which will be discussed here.
The GAP analysis also consists of four steps:
• Retirement and exit planning (including succession planning);
• Personal exertion;
• Return on investment (this is different to Guaranteed Return on Investment);
• Overheads (operating expenses).
Retirement and exit planning
At some point you will probably want to retire. If you know that date and how much money you will need by that point in time then you may well find there is a gap between your current savings and the amount you want by retirement.
Let’s say you want to retire in 10 years with $700,000 of investment capital and you currently have $400,000. That means you need to generate a further $300,000 of investment capital over the next 10 years, which is $30,000 per year after tax.
The first figure to go into your GAP analysis is a retirement and exit-planning figure of $30,000.
But a word of caution: none of us have the next 10 years promised to us, so just how prepared are you if the unexpected happens? “Hope” is not a strategy, so even if you think retirement is a long way off, the time to get serious about your planning is NOW!
You have three retirement options available:
• Sell the business – to family or a third party;
• Close the business;
• Retain the business – what I call “exit without exiting”.
The first option – selling the business – can include a “generational succession plan”. This can be an excellent option if the process is managed properly, however it can be a potential can-of-worms if it’s not. The most challenging issues facing family businesses are family-based issues more than they are business-based issues.
Succession planning should start as soon as family members begin working full-time in the business. Unless everyone’s expectations are made clear from the start, assumptions will be made…and we all know where that gets us.
All of these options require a degree of “grooming” or “positioning” the business to make it as attractive as possible for prospective owners because every dollar you drive to the bottom line is potentially worth two to five times that as a multiplier of earnings.
That, of course, poses the question: why would you sell a business to a new owner who will get their money back in two to five years while you take that same money and likely get a 5 per cent return if you’re lucky? That is why my preferred option is “exit without exiting”.
Personal exertion
Your personal work effort each week (your exertion) reflects your market salary. This is normally consumed and does not form part of your wealth calculation as your living expenses come from your personal exertion income.
A good way of looking at this is to ask yourself what you would pay someone else, a manager for example, to do what you do. Conversely you can ask what you would expect someone else to pay you if you worked for them.
If the market salary for your role is $50,000 for a 40-hour week and you work 60 hours, your adjusted market salary would be $75,000.
The second figure to go into your GAP analysis is a personal exertion figure of $75,000.
Return on investment (ROI)
Putting a figure on a “required return” is as much art as it is a science. ROI is what you expect to earn each year on the equity you have invested in your business.
Most private businesses sell for multiples of between two and five times their maintainable future earnings, which can be very different to historical profit. This can be a guide for understanding the risk premium to add to the risk-free rate offered by bank deposit rates.
The steps needed to assist in determining a ROI include determining the equity you have made in your business (what the business owes you) – let’s assume $400,000 – and ascribing a financial return that warrants your business risk – let’s aim for 27 per cent ROI, which is approximately halfway between what a willing buyer will offer you (they normally want a 33 per cent return) and what you think is fair (normally 20 per cent).
In other words, if your business has maintainable earnings producing an annual net profit of $100,000, a reasonable buyer would offer you $300,000 for your business. This would mean he recoups his outlay in three years, at which time the buyer would have achieved a 33 per cent return on his initial investment.
On the other hand, you probably want to sell your business for $500,000, which would mean it takes the buyer five years to recoup his initial outlay and would mean he achieves a 20 per cent return on his investment.
A happy medium of a 27 per cent return is usually the point at which a willing buyer and a willing seller will agree.
This return of 27 per cent is made up of two parts:
The “risk free” return – the rate any bank would pay you for having your funds on deposit with them;
The “risk premium” – consider general small business risk, the fact your funds cannot easily be withdrawn and specific industry risk such as a competitor opening up next door to you.
If your business owes you $400,000 at a 27 per cent return you should expect to generate $108,000 of extra gross profit from your capital investment.
The third figure to go into your GAP analysis is a return on investment of $108,000.
Overheads
The final step is to calculate overheads, which are all other costs below your gross margin line, including wages, rent, power, bank fees and more. The figure should include every cost in your profit and loss statement except product.
If your overheads are $350,000, this will form the final figure in your GAP analysis, which now looks like this:
• Retirement/exit planning – $30,000;
• Personal exertion – $75,000;
• Return on investment – $108,000;
• Overheads –$350,000;
• Gross profit required: $563,000.
In this example, the level of gross profit required each year for the next 10 years in order to achieve your business goals is one of more than $560,000.
How does your business compare?