What is your business worth? (Pharmacy Today – July 2011)

Markhams is often asked to value pharmacy businesses. While pharmacy businesses do have some unique characteristics, they are subject to the same basic value rules as other businesses. Value is represented by either the cash-flow the business can generate (discounted cash-flow valuation methodology) or the value of the underlying assets owned by the business (net tangible asset valuation methodology).

Ordinarily, the net tangible asset valuation methodology is used where all of the economic value of a business derives from its productive assets, for example, a property-owning company. Normally this methodology would only be used in a pharmacy context when the future of the business is uncertain. Because it is often difficult to determine accurate cash-flows for a long enough duration, a proxy for the discounted cash-flow methodology is the capitalisation of earnings method. It is this method that is the most commonly used for valuing pharmacy businesses in New Zealand.

The capitalisation of earnings theory suggests that a prospective purchaser will be prepared to pay to receive ongoing profits into the future. The capitalisation of earnings methodology has two components: one – establishing future maintainable earnings before interest and tax (EBIT). This involves making an assessment of likely ongoing profits after eliminating personal/non-market transactions and (very importantly) factoring in a market salary for the working owner. Two – establishing a required rate of return, or earnings multiple. The formula us a simple one; future maintainable EBIT multiplied by the earnings multiple = enterprise value.

The enterprise value is what the business would be worth if it were to have a “perfect” balance sheet, ie, no debt, more surplus assets. Normally, if someone were looking to purchase a pharmacy outright, then they would set up a new company and only purchase the parts of the business they needed. In this situation, the value paid would be similar to the enterprise value. This can, however, be quite different where you are buying into an existing company. You will be buying a share of the balance sheet on the settlement date so it is very important that the price paid is adjusted to reflect any surplus assets the company may hold (for example, the company may have a bank term deposit or owner’s car) and any debt (there could be bank loans and shareholder current accounts to be repaid, for example). The enterprise value would be increased to reflect surplus assets (by definition these are assets not necessarily for the running of the business) and reduced by the level of net debt (those monies that would need to be repaid at some time in the future).

Understanding how value is created and represented within your pharmacy business is extremely important for you as an owner. After all it is this that will determine how successful you are as a business person. The above is by no means a definitive guide to pharmacy valuation and we recommend discussing any valuation questions you may have with your professional advisor. Markhams is experienced in valuing pharmacies and would be happy to discuss the value of your pharmacy with you.

Pubilshed by Paul Rickerby, Markhams Christchurch in Pharmacy Today, July 2011

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