Quick Consultant: Financial Benchmarking Study Released & Valuation Red Flags

Okay, real quick, I want to share with you two small items before I get to the meat of my column for this month.

My first item is just an observation, and while it technically has nothing to do with printing, it does illustrate how old I am getting. Plus, it has really been bugging me these past few days.

The hair stylist I go to once a month (they used to be called barbers), told me the 15-year-old girlfriend of her 18-year-old son is pregnant and expecting a child in about three months.

I was sort of stunned to hear this, but I get the feeling that this kind of stuff happens all the time in high school. I tried to be courteous and asked what their plans were, once the baby was born. Well, since the girlfriend is only 15 she plans on living at home and she will return to school this fall and bring the baby with her. There is a day care center set up at the school, and it is supervised and operated by teen mothers.

Not only do the young mothers get to bring the babies to school, but they actually get high school credit for taking one or more child rearing courses. Of course, the sarcastic me wanted to ask her if her son got any credit for creating this situation to begin with, but I decided not to ask. Another thing that bugs me is wondering if the girl gets a failing grade in the course, do they take the baby away and put it up for adoption?

Okay, how many of you are old enough to share my amazement at the above, especially as to how it reflects how much things have changed in 50 years? Looking back on those days, I realize how naïve I really was.

Every once in a while, when I was in high school in the early 1960’s, you would hear about a popular girl from the junior class not showing up for the new fall semester. Sometimes a similar situation would happen mid-year. If you inquired about Cathy or Shirley’s whereabouts, someone would offer up, “Oh, I heard she went to live with her aunt in Connecticut or she went out west to see her sister.” I think many of us believed that. It was only later that I learned the “visiting Connecticut” story was a code of some type that meant the girl had gotten pregnant and that she had been forced to leave school.

Now kids get credit for this? I can’t help but wonder, if you have more than one child while you are in high school do you get additional credits, or are the original credits deducted since you obviously didn’t learn from the first course? Oh well, enough rants for now.

Benchmarking Study Released
My second not so small item is that by the time you read this column the 15th edition of the NAQP Benchmarking Study (formerly called the Operating Ratio Study) will have been released.

It is 80+ pages in length and contains more than 240 profit and loss, balance sheet, and key ratio pages for just about every possible breakout you can imagine. Comparisons and breakouts range from large firms vs. small, high profit vs. low profit, companies with sales reps vs. those with none, and of course, franchise operations vs. independent operations, just to name a few.

The study contains, as usual, an outstanding Executive Summary by industry expert Larry Hunt. Hunt reviews the industry’s ups and downs over the past two years and offers suggestions as to how readers can become more profitable. If you would like to order this popular study, simply call the association at 800/642-6275 ext. 4, or go to www.napl.org and click on NAPL Store.

If you participated in this study, you should have already received your customized 20-page report via email during the first week in May.

Selling & Buying Opportunities
During the course of an average month, I prepare between five to 15 print shop valuations. Sometimes they go pretty smoothly and sometimes they turn out to be a nightmare.

Most of these valuations are conducted for selling owners who want to exit the industry for one reason or another. Some sellers are approaching their 70’s and they just want to retire. Others have serious health conditions and their doctor has told them to sell the business and get out, before it kills them! Some folks have had a rough time these past three or four years and just can’t seem to get their businesses back on track. They are now ready to throw in the towel.

Other situations involve one partner wanting to be bought out by a remaining partner. Sometimes there is a divorce decree that specifies the business be valued so it can be apportioned properly as part of the divorce settlement. Sometimes, in the case of franchises, the franchisor often has a list of qualified buyers interested in buying a printing firm. The problem for the franchisors, as well as many others, is that potential sellers (their own franchisees) often lack even the most fundamental understanding of business valuation principles.

By the way, don’t let me forget to mention that there are a good number of qualified buyers out there. Most of them are printers who are looking to expand their book of business and possibly their territory by buying out competitors. Many of them have already done it two or three times.

Generally speaking, these buyers are far more savvy about true values than the sellers they deal with. As a general rule, they are prepared to pay a “fair market” price for the business. The problem is that buyers, relying upon nothing more than rumors and old wives’ tales, are sometimes expecting two to three times what their business is really worth or what the buyer is offering.

Basic Valuation Elements
In “Print Shop for Sale,” a book written by Larry Hunt and me, we describe some basic elements involved in valuing a business, especially a capital intensive business such as printing.

Some key elements discussed in the book include calculating “excess earnings,” arriving at an “excess earnings multiplier,” and determining the value of the net tangible assets to be sold as represented on the balance sheet.

Some balance sheets are very clean, well organized, and require little additional information. A basic balance sheet represents the total financial strength or health of a company from its inception. It typically presents the following:

  • Current Assets
  • Long Term Assets
  • Total Assets
  • Current Liabilities
  • Long Term Liabilities
  • Total Liabilities
  • Net Worth

As a reminder, net worth is represented by “total assets” less “total liabilities.” Almost without exception, each item falling under these categories ought to be a tangible asset or liability, one that you can touch, collect, sell, or buy for a specific amount of money. Tangible assets and liabilities are hard items that can be clearly defined and substantiated. A loan payable to a bank for $150,000 is definitely a tangible liability.

However, a loan you made to the company for $150,000 three years ago is a lot less tangible, at least in my eyes, and more importantly, in the eyes of most buyers. This is especially true if there is no record of repayment activity. These types of notes are nothing more than “red flags” to a potential buyer.

If you keep questionable assets and liabilities on the books, especially personal ones, and you expect to somehow be reimbursed when you sell the business, you are in for a sad awakening. Most likely it won’t happen.

Very few buyers are going to pay you back for loans you made to your company. If they were real loans they should have been paid back. Buyers are buying value, and the essence of value means the ability of a business to pay off its financial obligations. An unpaid note payable to stockholders is the antithesis of this. So what is the bottom line? Be prepared to write off most, if not all, personal notes due to you from your company.

Two Red Flags in Valuations
What two “red flags” cause most of the problems during a valuation? The values assigned to “goodwill” and “amortization.” These two terms are among the most misunderstood of all valuation elements. Most people don’t understand these entries, even when they appear on their own balance sheets. And those who do often intentionally overstate them in order to inflate the value of a business.

I am currently looking at a balance sheet that lists a net worth of approximately $700,000. Unfortunately, a closer look reveals the owner has listed approximately $910,000 in intangible assets. If I subtract the latter, we end up with a corporation with a negative net worth, based upon tangible assets and liabilities. That’s not a good start on a valuation.

First and foremost, by their very definition, items such as “goodwill” or “amortization” and any value whatsoever assigned to them are intangible. They have no hard value and lack the paper trail and substantiation traditionally found backing all other hard assets and liabilities.

I know some of you (especially some with accounting backgrounds) will hate to hear me say this, but the hard facts are that until a business goes through the sales process, the value of goodwill cannot be determined. By definition, goodwill is represented by the amount the business is sold for above and beyond the fair market value of the tangible net assets. In essence, the value of goodwill can only be recognized after the business has been sold.

Anytime I see a balance sheet category listed as “other assets,” I immediately scrutinize it with my buyer’s hat on. I often conclude that most, if not all, the entries are not only intangible, but in some cases, represent nothing much more than a sprinkling of fairy dust. Many buyers look at goodwill as a phantom asset.

Please do not think that I am saying that businesses do not have goodwill, because they certainly do. Anytime a business sells for more than the fair market value of its tangible assets, the difference is technically allocated to goodwill. However, common sense says that you cannot include goodwill or amortization in the same financial valuation formula that you are using to calculate a value that will, most often, represent or include goodwill.

If you would like to read additional discussion and comments about valuation theories, EBITDA, depreciation, etc., visit our Q&A webpage that is dedicated to these subjects at: http://www.printshopsforsale.net/faq.html

Simple Marketing Idea
A couple of years ago I was going through the mail and one #10 envelope jumped out from the rest. Yes, it was an invoice like so many others, but this one was from a regional cable company and on the outside of the envelope was a nice, from the heart “thank you” message. I was impressed enough that we decided to do the same thing with the window envelopes we use to mail out our invoices and statements.

The message is printed in an eye-catching bright green ink and says, “Thank you for being a customer of Paragon Printing & Graphics!”

By the way, for those who are wondering, yes, we do mail all our invoices and we do send statements out at the end of the 30 days to any customers that have an outstanding balance.