The fundamental rule in valuing an automotive repair business is pretty simple. The more money your shop makes – the more valuable it is. That statement is true and it really is that easy. Like most things in life, the truth is a fairly simple proposition. What gets complicated is avoiding the truth. I have found that when a human being is presented with truth that they don’t like, they will seek to avoid it. Buyers and sellers of auto repair shops are human beings. Business brokers are human beings too. And to one degree or another, all three of these players in a deal are capable of complicating a transaction to rationalize the desired outcome.
Cash flow is the sum total of all provable financial compensation that a shop owner receives by virtue of the fact that he owns the shop.
or
Everything the shop pays you or pays for you.
It’s easy really. How much money does the shop make for the owner? Here’s how you calculate it. The income statement is the place to start. Net income is usually a number that is managed downward in an attempt to minimize taxes. Everybody knows that. It’s still money though. At the end of the year it represents how much money the business earned after all expenses. So you start there. Let’s say it’s $75k. The next step is to add back all provable expenses that benefit the owner. Does the owner take a salary? If he does, and most owners do, then add that amount back. Let’s say the owner’s salary is $90k. Does the company pay for health insurance for the owner or his family? It’s fairly common for that to happen so let’s pretend that amount is $10k. We’ll add that back too. These are pretty cut and dried so I’m guessing you get the idea but here it is so far so nobody gets lost:
NET INCOME $75,000
OWNER’S SALARY $90,000
OWNER’S HEALTH INSURANCE $10,000
CASH FLOW $175,000
Some addbacks aren’t quite as obvious. If a shop owner tells me that he attends SEMA every year in Las Vegas and that travel expense is on his P&L for $5,000…but he also tells me that the trip is not necessary to the day to day operations of the shop…then ok…that’s an addback. Understand the difference here. This trip is completely legitimate as a deduction. The reason it’s an addback is that the trip was undertaken to improve the future performance of the shop and the shop is being valued based on current performance. So the argument is that the shop could continue to operate at its current level of revenue and profitability even if the new owner did not travel to Las Vegas for the SEMA convention. So that’s an addback. There are other examples of expenses that could be added back that fall into this category. This list could get to be quite lengthy…so we’ll just stop here. Let’s update the cash flow calculation:
NET INCOME $75,000
OWNER’S SALARY $90,000
OWNER’S HEALTH INSURANCE $10,000
NON NECCESARY TRAVEL $5,000
CASH FLOW $180,000
Now let’s bring the rule back into play and see what we should ask. The rule is that auto repair businesses sell for between 2x and 3x cash flow.
ASKING PRICE at 2.5X CASH FLOW $450,000 (Probably too low)
ASKING PRICE at 3X CASH FLOW $540,000 (Probably a touch too high)
If I was sitting in this shop owner’s office (with the owner’s dog…there’s usually one hanging around) I would tell that shop owner to ask $525k. I really think that’s the right number. An asking price of $525k on a cash flow of $180k is just about right. So that’s the example. And here’s how to apply it to your shop: Calculate your cash flow then apply a multiple. If your cash flow is about $100k, your multiple is low 2s. If your cash flow is about $200k then your multiple is high 2s. If your cash flow is $250k or $300k then your multiple is probably pretty close to 3. It’s a sliding scale. The more money you make the better the multiple.
There are two big errors that are made in this process. The first one is expecting a premium for potential. It’s human nature to hear a number and then rationalize why it should be higher. And the easiest way to do that is charging a premium for potential. This is a trap…it’s an attempt to avoid the truth…do not fall into it! Buyers don’t care about potential. They don’t care how much money you could make next year or how much money you made five years ago. Another version of this is “My shop has a really good reputation.” This will sound harsh, but the buyers don’t care. All they care about is how much money you are making right now. I have talked to thousands of buyers over the years and I can’t think of a single buyer that has used the word potential. It’s a hard pill swallow, but it’s true, all that matters is how much money you make.
The second big error is cash. It’s easy to miss some cash sales. If a customer hands the business owner cash for a job…the controls are sometimes not in place to force the recognition of that sale. And if that sale slips through the cracks, it hurts profitability and decreases the price that the seller and the broker can reasonably defend. Tighten up the process so cash is not missed.
There are a hundred other elements to selling an auto repair shop. Determining a fair asking price is the first. It’s important to get it right.