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How to calculate the value of a going concern?

Concerns when buying a business.

Entrepreneur

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Calculations involved with buying a business

How to calculate the value of a going concern

When buying an existing business you will need to negotiate with the owner but it is always easiest to agree on a formula.
Standard Bank’s advice on determining the value of a business includes the following formula:

  1. Net worth of the business – liquidation value of the assets minus the liabilities
  2. Your present earning power – annual earnings with an equal amount of net worth (say 15%)
  3. Add a reasonable annual salary for owner or manager
  4. Average earnings required (item 2 plus item 3)
  5. Determine the average annual net earnings of the business (net profit before owner’s salary) over the last few years
  6. Extra earning power (item 5 minus item 4)
  7. Ask yourself over how many years you are prepared to sacrifice the extra earning power of the business to pay for the goodwill (item 6 multiplied by item 3)
  8. Final price (item 1 plus item 7)

Get a professional valuation

It is well worth the time and expense to get a professional business valuation. An accountant or lawyer can help locate the right professional. Inexperienced sellers have a tendency to set a price before they have established the value in the real world. Valuation is based on quantifiable criteria, not the owner’s personal estimation. To avoid this mistake, get an objective third-party valuation.

Methods

There are different approaches to valuing a small business. These include assets-based, income-based and market-based valuations.

Asset-based valuation

This is the simplest way to value a business. Examples of tangible assets include accounts receivable, furniture and fixtures, equipment, inventory, customer contracts, vehicles, leasehold improvements, prepaid expenses (paid insurance premiums for example), franchise agreements.

If you own the real estate that your business occupies you may be better off selling it separately from the business, which means it won’t be part of this valuation. However, if the business is dependent on the current location, then add the value of the real estate in this step.

Income-based valuation

The income-based approach determines the value of a business based on its ability to generate desired economic benefit for the owners. The key objective of the income-based method is to determine the business value based on income statements. Some valuators prefer to use the company’s income before depreciation, interest and tax while others do not. Much depends on the type of business that is for sale.

Market-based valuation

The market approach based valuation method is based primarily on the market price for similar businesses at a given point in time.

Preparation for sale

First impressions make a big difference. Before buyers come to see the business make sure the offices are neat and clean. Remove any unnecessary clutter. Shred old documents. Replace worn out and broken furniture. Update signage.

Confidentiality is important

If the word gets out that your business is on the market, it could adversely affect sales and your relationship with your staff. A good broker will know how to simultaneously market your business and maintain strict confidentiality. Consider your employees. Decide how and when you will communicate the sale with your employees.

Tips

  • Update your company’s financial statements
  • Buyers will typically require 2 to 3 years of financial statements (profit-and-loss statements, balance sheets and/or tax returns) for their evaluation.
  • Make sure you have supporting documentation for nonoperational expenses (fringe benefits such as your personal health insurance).
  • Prepare a simple list of the business’s important furniture, fixtures and equipment.
  • Document your inventory.
  • Clean-up your accounts payable and any pending legal, employee or environmental issues.
  • Organise your legal paperwork such as operating licenses, property leases, customer agreements and insurance documents.

How to calculate the goodwill equation

The intangible known as ‘goodwill’ is a key consideration in a business’s value. Goodwill may range from a long-established distribution network to a sterling market reputation. And sometimes a buyer will pay top dollar to obtain a business with great goodwill. While there is much talk of goodwill when businesses exchange ownership, but the concept can be vague in some people’s minds so it’s something you need to discuss.

Generally speaking, goodwill can be calculated by working out the difference between the book value of the assets (equipment and stock) and the selling price of the business. Make sure you check the stock and all the assets and don’t take on anything that is damaged. You will need to do a stock take again on the day you take over the business to determine whether there is any discrepancy between the amount of stock agreed upon when the purchasing price was decided and what you are actually getting.

How do you value a business owning only ‘Intellectual Property’?

The approach to valuing intellectual property depends on the specific circumstances and type of intellectual property to be valued.

We value a business on the same basis that we value any other asset such as a building or a machine, and we would look at four approaches, market price, historical cost, replacement cost and income stream,” explains Faan Wolvaardt Trademark Manager at Bowman Gilfillan.

“In terms of market price, it would be difficult to attach a value as there probably isn’t enough comparable information. Historical cost would also be problematic especially if it’s a trademark. When trying to determine value measured against replacement costs this method would also be difficult as the cost and the value are not the same,” Wolvaardt says.

Preferred method

The income stream valuation is the preferred method if we are dealing with trademarks. This value would be based on the future economic benefits produced by the intellectual property. “We can accept that the value of the trademark equates to the amount that the trademark proprietor would have paid in royalties if the proprietor didn’t own the trademark. The calculation revolves around turnover, royalty rate and the expected life of the brand and that gives the future income stream”, explains Wolvaardt.

Current and future money

The future income can be converted into current money by means of a standard net present value (NPV) calculation. In finance, the net present value (NPV) or net present worth (NPW) is a standard method for using the time value of money to appraise long-term projects. Valuation is not a science, but an external judgment.

Because of the increasing importance of intellectual property in a company’s valuation, turning ideas and innovation into profit is, and will continue to be, one of the biggest challenges facing business.

What is meant by the term ‘acquisition’?

There’s only one real way to achieve massive growth literally overnight, and that’s by buying somebody else’s company. Acquisition has become one of the most popular ways to grow today. Since 1990, the annual number of mergers and acquisitions has doubled, meaning that this is the most popular era ever for growth by acquisition.

Why do businesses acquire other businesses?

Companies choose to grow by acquiring others to increase market share, to gain access to promising new technologies, to achieve synergies in their operations, to tap well-developed distribution channels, to obtain control of undervalued assets, and a myriad other reasons.

Risk

But acquisition can be risky because many things can go wrong with even a well-laid plan to grow by acquiring: cultures may clash, key employees may leave, synergies may fail to emerge, assets may be less valuable than perceived, and costs may skyrocket rather than fall. Still, perhaps because of the appeal of instant growth, acquisition is an increasingly common way to expand.

What is the next step after agreeing to a purchase price?

Once you have agreed on a purchasing price, draft a letter of intent. It’s also a good idea to consult with various professionals at this point. Attorneys, tax experts and accountants will all be able to offer expert advice and raise any red flags. Finally, work out the payment terms and bear in mind that paying everything upfront leaves you little room for comeback if problems arise, as well as negatively affecting your cash flow.

 

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Doing Business in SA

Free Payslip And Contract Of Employment Template Download

Download your free payslip and contract of employment here to get you started in the right direction.

Menét Hamel

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In your downloads you will find the following resources below:

1. A free payslip template with formula on how to calculate tax (PAYE), UIF, etc for a start-up business.

2. A standard contract of employment (template) that complies with all the relevant laws.

The payslip template is merely an example and should you need to have anything checked in terms of your remuneration structure, we can put them in contact with our remuneration specialists in Johannesburg, Tax Consulting.

Related: 5 Ways to Make Your Payroll & HR Solution Pay for Itself


Download your payslip template 

When launching your business you don’t want to be blindsided by the little but impactful costs, like PAYE or UIF. Ensure you have everything covered by using this payslip template.


Similarly, the permanent contract of employment should be read carefully and changes should be made in line with the offer of employment and the company policies and procedures. Please note the template provided is for a permanent placement.


Download your contract of employment template

When employing staff you should ensure the contract is legal and legally binding. Customise this contract of employment to suit your business and what you can offer your employees.


Related: How the Right Technology Makes DIY Payroll As Easy As 1-2-3

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Doing Business in SA

What steps do I need to take to start manufacturing toilet paper?

This comprehensive guide takes you through everything you need to know to start a toilet paper business.

Entrepreneur

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The business of producing toilet paper has been recognised as one of the fastest developing assembling commercial initiatives in Africa.

Toilet paper is used in our homes, work places, schools, hotels, restaurants, shops, maternity homes, hospitals, churches, clubs and many others. It can be used in various other ways such as cleaning up messes and decoration.

The difference between toilet paper and other tissues is that it is created to breakdown in septic tanks and other tissues don’t necessarily do this.

We recommend: What steps do I need to take to start manufacturing toilet paper?

To start and run a business, it is not enough just to have a good, viable idea. You also need to have the right skills, attitude and personality to make the enterprise succeed.

Benefits of starting a toilet paper production business

  • It has a simple production procedures
  • There are not many product offerings or varieties
  • Simple organisational involved
  • High interest on the product
  • Easy to market
  • Product is a primary necessity in society.

Possible challenges of starting a toilet paper production business

problems-with-making-toilet-paper

  • The biggest constraint will be the insufficient amount of planted trees. This will affect you as this is where you will harvest your raw materials from. This can result in a reduction of plantation productivity. According to the Paper Manufacturers Association of South Africa 60% of all plantation trees are planted and grown especially for pulp and paper production.
  • You will need to apply for water permits to meet the terms of the regulatory framework managing water usage. This is a long and difficult process and can limit you from achieving profitable operations.
  • Transport, labour and licence costs will have a negative impact on your ability to competitively trade. You will need to apply cost control measures to remain competitive.

Did you know?

  • In an average public bathroom, it takes 71 separate visits to finish a single roll of toilet paper.

Financing your venture

It’s most likely that you will need finance when setting up a toilet roll production business. The toilet roll production equipment is available in South Africa and ranges for a single machine from R175 000 for the bottom end of the range model to R500 000 for a fully automated machine.

Manufacturing plants are also very large in size which means financing it will be quite expensive. You should use your capital to purchase the equipment you’ll need.

Try and save money by buying economical but high quality equipment. Once you have all your equipment find a premise that will accommodate all of it. Once that is completed then contact stores and potential clients.

Related: Attention Black Entrepreneurs: Start-Up Funding From Government Grants & Funds

You can save money by renting or buying an inexpensive lot for your toilet paper business. You could even start in a smaller building and when you have increased your funds, upgrade your facilities into a bigger space. Make sure to take all of the costs into account when trying to finance your toilet paper business.

You’ll have to include raw material required to make the rolls. These are supplied in jumbo tissue rolls and cost from R6 600 per ton. You will also have to take into account staff.

Zhauns, a supplier of business opportunity machinery supports BEE by offering a variety of empowering programs for street vendors, unemployed and disadvantaged groups through consortiums, local and international joint ventures and has financial links which assist entrepreneurs in need of funding.

Related: Government Funding and Grants for Small Businesses

A start-up would need two-five people operate a small business of this kind. It takes about three months to set up the business and to properly train staff to operate machinery”. Zhauns offer free training when they install equipment purchased through them.

Planning

toilet-paper-stacked

Planning is always your starting point when starting a new business. There are several techniques you can use for your planning process. You can use ready and existing techniques and plans or you can use innovative techniques which will make your toilet paper business more unique.

Focus on the specifics of what you will need for your toilet paper business such as equipment, employees, property and raw materials. Making errors during the planning phase is normal. After your plan is finalised it should be flexible enough that you can add changes.

In this industry you are not just competing with local manufacturers. When you become a toilet paper business owner you have to figure out how you’re going to compete with different international manufacturers.

Speak to owners of similar businesses

The best source of information you can find about an area of business, is other toilet paper business owners. They will tell you in practical terms whether your ideas are feasible or not.

To locate similar businesses which can give you advice on any aspect of their toilet paper business, contact your local Chamber of Commerce. Shereen Crowie of Curviro Trading says: “It’s a commodity with no age restriction and no seasonal production demands.”

For support and guidance

toilet-paper-support-structure

If you are going to be a toilet paper business owner you need to have business skills, even more so than technical skills about your product or service. This means you have to understand finance.

You need to know how much your idea is going to cost you, whether it will make enough money to pay back these costs and make enough in addition to satisfy your requirements.

The DTI (Department of Trade and Industry) recognises that support in the form of advice from specialist organisations is vital and the offer support groups to SME businesses.

One such arm is Khula Enterprise Finance which is a wholesale finance institution that has well-developed ties in the public and private sectors.

Through these channels – which include commercial banks, retail financial institutions, specialist funds and joint ventures they play an effective role in order to bridge finance gaps that are not addressed by commercial financial institutions in the small business sector.

Did you know?

  • People use on average 8.6 sheets per trip, which is a total of 57 sheets per day. That’s an annual total of 20,805 sheets.

Training

It is recommended to get training when joining the toilet paper business industry. There are many essential practical skills which you will need when starting a toilet paper business.

There are courses offered by universities which will help improve your skills and understanding of the technology involved. You can alternatively get training from current experts in this field.

You can apply for internships at factories and get first-hand experience. If this is your plan of action make sure to take very detailed notes about all the process involved.

Draw up a business plan

Business plans are essential for businesses from when they start out to years later when your businesses has evolved and improved.

It becomes a guide for you and your employees to track whether your business has gone off course from the core of quality production. Experts can be hired to help you draw up a toilet paper business plan for a fee.

Business plans can be used to organise everything from your marketing strategy to the strengths and weaknesses of your business.

We recommend: Business Plan Examples to Get You Going

It will help your toilet paper business keep clear objectives as well as making your priorities recognisable. Milestones recorded in your toilet paper business plan will help you follow your progress.

Location

Choose a good location in an industrial area for your toilet paper business. It’s recommended that you get a realtor, since they are the experts in their field.

They will advise you on which buildings are better for your toilet paper business and which ones would be unsuitable.

Make enough time to view each property before purchasing or renting it. Your toilet paper business can’t be in a residential area.

Types of Machinery

toilet-paper-machinery

You will need to buy or rent the necessary equipment with the finances you have. Some of the machinery that you need to get going with your toilet paper business is:

  • Core making cutting machine – This produces the brown cardboard core that the tissue is wrapped around.
  • Jumbo reel winding machine– This winds the tissue paper from the jumbo reels to the cardboard core. It will automatically stop at a programmed size.
  • Embossment attachments or embossing machines – Embossments are the prints on the surface of the tissue and the tissue roll can either be plain or embossed.
  • Band saw cutting machine – this cuts the paper into the right side.
  • Other machinery requirements:
    • Generator for power outages
    • Auxiliary equipment
    • Transportation – its optional but can be essential.

We recommend: Where can I hire the machinery needed to manufacture toilet rolls?

Employees

This type of business will require trained employees. It would be a definite advantage if you hired experienced operators or people experienced in similar industries.

This will allow you to hit the ground running instead of slowly training your staff from scratch.

Hiring inexperienced people can also cause a decline in the quality of your production as well as a decline in the level of your toilet paper businesses productivity.

Marketing strategies

Once production has started you will need to come up with various ways of distributing your product.

Since your brand is new, you will most likely have to do a demanding marketing drive so that customers know who you are.

Customers won’t buy your brand if they don’t know who you are. Advertising consultants can help your toilet paper business with effective strategies which will help increase sales.

Which works better buying machinery first or getting orders before buying equipment?

toilet-paper-orders

Look at your market before spending the money. It is good business practice to establish if there is a market for your product before buying expensive equipment. For this reason, it is vital to do research and to prepare a business plan.

Renting manufacturing equipment for this purpose may be a solution. Once the toilet paper business is up and running you can then consider buying your own machines.

Buying outright can result in a huge drain on cash in the first year of your toilet paper business.

Did you know?

  • In South Africa a family of four uses approximately one toilet roll every 1.5 days

Example of innovative thinking

Chandaria Industries operates out of Kenya and Tanzania. They sell their products in 15 African countries.

What sets them apart from their competitors is they make their recycled toilet paper from used paper.

What innovative thinking does for them, their communities and their country:

  • They are making money from recycling
  • They are transforming waste into a necessity
  • They are now a source of national wealth
  • They provide employment for many thousands of people

Just the used paper recycling activities creates nearly 20 000 jobs. By doing this they have saved over 30 million trees since they started in 1964. They still have more room to grow, saying that they don’t get as much used paper as they need.

Expansion options

Toilet paper will always be a necessity in people’s lives. Where your toilet paper business can grow to:

  • Custom toilet paper – creating toilet paper with personalised images or custom images
  • Various sizes – You could expand your toilet paper business into various other toilet paper sizes and thicknesses
  • Various tissue paper opportunities – You can expand your business into the tissue paper manufacturing business

Paper Manufacturers Association of South Africa (Pamsa) executive director, Jane Molony says that the pulp and paper industry’s is continuing to grow and make profits because of their energy-saving initiatives.

Molony also says that the value of the pulp and paper industry (excluding forests and recycling) in 2014 was around R27.8 billion.

Tissue paper achieved a yearly turnover of R2.5 billion in 2014 which is a yearly growth of 2.7% since 2009.

This industry has large growth potential and is a great business opportunity. Toilet paper has become a basic need all across the world. It can’t be recycled so there is always need for more.

Every single person on the planet uses it on a daily basis. Why shouldn’t you be the one making it and selling it to them?

Related: Free SWOT Analysis Template

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Doing Business in SA

What should I know before registering a holding company and how do I go about doing it?

Holding company pros and cons.

Entrepreneur

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What is a Holding Company?

A holding company is one that owns at least 50% of the companies companies’ stock. It is a company that doesn’t trade but only has one purpose which is to own shares in other companies.

Under what circumstances would one need to register a Holding Company?

A holding company is a firm that owns other companies’ outstanding stock. It usually refers to a company which does not produce goods or services itself.

Related: The Basics Of Registering A New Company

Its only purpose is owning shares of other companies.

From a financial point of view, it is usually possible to obtain control of another company with less investment than would be required in a merger or consolidation.

However, the decision on how to split companies depends on the industries in which you operate the shareholding structures, risk profiles and many other issues that will be specific to your situation. This is why professional help is highly recommended.

What are the Pros and Cons of a Holding Company?

The Pros:

  • The shares of stock in the subsidiary company are held as assets on the books of the parent company and can be used as collateral for additional debt financing.
  • Holding companies and their subsidiaries are considered separate legal entities, so that the assets of the parent company and the individual subsidiaries are protected against creditors’ claims against one of the subsidiaries.
  • Each subsidiary retains its own management team, and the subsidiaries become responsible to the parent company on a profit and loss basis.
  • The law sees a company as separate from its shareholders and directors. This means that in a CC, the assets and debts of the business belong to the company and the assets and debts of the shareholders and directors have nothing to do with the Company.

 The Cons:

  • Companies have to obey all the rules of the Companies Act, which is a long and complicated law.
  • A company has to keep detailed records. A professional organisation is needed to help explain which records must be kept.
  • It is difficult to terminate a company. A lawyer’s help is needed.

What legal entity must one register for a Holding Company?

The best route is to register as a (Pty) Ltd. This is a limited liability entity and the registration process of a (Pty) Ltd is very cumbersome and professional help is almost always sought.

Related: 3 Key Law Areas To Know When You Launch That Start-up

A Close Corporation can also hold shares in a company and can become the holding corporation in a group of companies.

How do you go about registering a Holding Company?

To register a holding company you need to consult an attorney in order to lodge proper compiled documentation at CIPRO in Pretoria. The Shelf Co Warehouse registers most Companies and Close Corporations in South Africa.

For more information visit:
http://www.cipc.co.za/
http://www.pty-online.co.za/


Related: The Definitive List Of South African Business Incubators For Start-Ups

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