Return on investment is the time it takes to recoup the money spent. If it takes 2 years you are effectively getting a 50% annual return on your investment. ROI is one method used to determine the business value.
Return on Investment is calculated on the adjusted net profit of the business divided by the total purchase price. For example a business that has an adjusted net profit of $100,000 and the current accepted ROI range is 30%-50%. At 30% it would take 3.3 years to recoup your purchase cost, at 50% it would take 2 years. Calculate the ROI as follows:-
| Adjusted Net Profit | $100,000 x 100 = 30% (3.3 Years) | $100,000 x 100 = 50% (2 Years) |
| Price | $333,000 | $200,000 |
The total purchase price for this business including Goodwill, Plant & Equipment and Stock is between $200,000 and $333,000.
Many factors influence where a business actually fits in this scale. These can include location, number of years established, length of lease, owner involvement, staff, contracts, competition etc.
As a rule, the stronger the business type, the lower the Return on Investment.
For example, corner deli/convenience stores are under pressure from service stations who are now stocking all the traditional delicatessen lines and major supermarkets and shopping centres now operating 7 days. Buyers who may have been prepared to accept a 50% return (2 Years) on this type of business some years ago now want their investment back in 1 year or less. A 100% or more ROI
Some accountants use a general rule of a Return on Investment over 2.5 years. (40%)
Business prices are normally calculated using sales data for similar businesses, considering current market demand and the prevailing economic climate. ROI is generally applied to businesses with a value of up to 1 million.
Please note that this information is of a general nature only. Buyers and Sellers are urged to seek independent financial and legal advice when buying or selling a business.
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