I have to admit, when I first heard this term, I had a picture of a redback spider in my head. Needless to say, I wasn’t too fond of the word at first.

But once I got my head around it, boy did it open my eyes. It’s an essential part of understanding the true profitability of a business.

… so what is an addback?

An addback is an unusual or non-business expense that is taken out of the profit & loss statement. This lifts up the business’ net profit to its true operational profitability for prospective business buyers.

But should we be fudging the financial statements?

As part of an accountant’s job to help businesses minimise their taxes, they can apply expenses like interest on a business loan to their business. This reduces the net profit of the business, which in turn reduces the tax the owner has to pay on their income.

Another example is depreciation. Like the above, depreciation can be claimed as an expense, which reduces the net profit of the business (and thus the tax the owner has to pay).

So what’s the significance? Depreciation and interest on a business loan do not affect the actual running of the business, and so shouldn’t be used to determine the true profitability of the business.

OK, so why is it called an ADDback? Isn’t it about taking out expenses?

OK, this part gets a little into accounting-speak, so if you don’t understand what I mean, let me know below and I’ll explain.

This is what a typical P&L (profit & loss statement) looks like.

Sales	$a
– COGS	$b
Gross Profit ($a – $b) =	$c
– Expenses	$d
Net Profit ($c – $d) =	$e

Now, that’s all fine and good, but when you want to lift the profitability of a business to its maintainable net profit (i.e. with addbacks included), you include what’s called an addback schedule.

The addback schedule contains a list of addbacks to ADD back onto the net profit. What it essentially does is reverse those expense items so you get a better appreciation of the maintainable net profit of the business.

So it looks like this now:

Sales	$a
– COGS	$b
Gross Profit ($a – $b) =	$c
– Expenses	$d
Net Profit ($c – $d) =	$e
+ Addbacks	$f
Maintainable Net Profit ($e + $f) =	$g

Hope that explains it. If you don’t get it, leave a comment below and I’ll get back to you.

Otherwise, if you have any other questions about buying or selling a business, please let me know in the comments.

Chris Khoo
Business Broker

If you’ve started to look at business listings online (or offline), you’ll see a common term WIWO, which is shown with the price.

What does it mean? It stands for walk in walk out. It means that on the day of settlement, the old owner walks out, and the new owner walks in to run the business.  It differs from $price + SAV in that a stocktake does not occur.

Essentially, the new owner buys everything “as is”.

For example, you might be looking at a hairdresser for sale and it could say something like $180,000 WIWO. When it comes to settlement, aside from a few transaction fees, the buyer will pay the seller $180,000 for the business.

But why does it matter?

Many businesses are sold $price + SAV. The figure that is paid on settlement can differ depending on how much stock that business is holding at settlement. This is checked by both buyer and seller through a stocktake.

So with this in mind, you’ll see listings shown as $price + SAV, or $price WIWO. If you see both, then it’s wrong (which I’m sad to say I’ve seen a few times).

Is WIWO useful?

It’s generally used for businesses with very little or no stock.

Also in some businesses, it’s very hard to value the stock at settlement (e.g. manufacturing), so buyers and sellers may prefer to avoid doing the stocktake altogether and sell as WIWO.

If you’re interested in buying a business, sign up to my weekly newsletter on the right.  I promise you’ll get value out of it!

Have you been looking at business listings on the Internet and wondered what SAV meant?

It stands for Stock At Value, and it’s the value of the stock in a business at cost price. If you see a business listing saying “$price + SAV”, then you know the price of the business excludes stock.

It’s generally used for cafes, restaurants and retail businesses, where the business requires stock on hand to trade with. It’s not easy to estimate how much stock a business will have, but you can safely assume it shouldn’t be too much for a food business. With retail businesses, it’ll generally be alot.

But some of you may be asking, why do I need a separate figure for stock? Can’t we just lump it all together when buying a business?

Good question! Let me explain.

When a buyer goes out to buy a business, it’s not just a matter of writing a cheque out to the seller, and the seller handing you the keys and walking away forever. There is generally a lengthy process for the buyer to do their due diligence, finance and training before the business is handed over (i.e. settled).

During this time, the business would’ve bought and sold stock, which will vary the amount of stock to trade with. So on the day before settlement, the buyer and seller will get together to do a stocktake. Whatever the final amount they agree on should be close to the SAV, and is paid by the buyer on settlement.

Note: There is another common variation to this arrangement called WIWO.

If you’re interested in buying a business, sign up to my weekly newsletter on the right.  I promise you’ll get value out of it!

At times when I use the term “multiplier” or “multiple” as a business broker, many business owners screw up their faces and go “What?”. So I thought I might explain it here for your benefit.

The multiplier is the number of years it takes to recoup an investment in a business, based on the value of money today. For example, if I bought a business at $350,000 and EBIT (earnings before interest & tax) is $100,000 a year, then the multiplier for that business is the purchase price of the business divided by EBIT, which is 350K / 100K = 3.5x.

If we raise the profit to $150,000 a year, then the multiplier lowers to about 2.3x.

So a rule of thumb is – the smaller the multiplier, the more money it makes (and vice versa). But always keep in mind… if a business makes more money in a shorter amount of time, there’s probably a higher level of risk involved as well.

How About ROI or P/E?

You can also convert the earnings multiplier into a ROI (return on investment) figure by calculating 1 divided by the multiplier. So if you have an earnings multiplier of 2, 1 divided by 2 equals 50% ROI.

And also for all you share investors out there, the earnings multiplier is exactly the same as the P/E ratio (price earnings ratio).

If you have any questions about buying or selling a business, you can ask me a question anytime.

Chris Khoo
Business Broker