Capitalisation Rate vs Adjustments – What’s more important in a pharmacy business sale?
When I’m selling a pharmacy business, the first question I often get asked by interested parties is, “What is the capitalisation rate on the sale?” That is, what capitalisation rate have I applied to the Adjusted Net Profit to get to the asking price for the business.
While the capitalisation rate applied on a sale is important, it is also very important (and in my opinion perhaps more important) to determine the adjustments that have been applied to the reported figures to get to the Adjusted Net Profit.
The reason that I say it is perhaps more important is because, one adjustment to the figures can often have a much more significant impact on the calculated price than a change in capitalisation rate. Let me show an example to illustrate.
Example:
Pharmacies are priced on the capitalisation of future maintainable earnings methodology, which is as follows:
Price = Future Maintainable Earnings (or Adjusted Net Profit) / Capitalisation Rate
So, if we assume a pharmacy business has an Adjusted Net Profit of $150,000 and is assessed with a 15% capitalistion rate, then the price will be $1 million:
Price = $150,000 / 15% = $1,000,000
Now, let’s assume that the capitalisation rate applied is 14% instead of 15%. The resultant price will be as follows:
Price = $150,000 / 14% = $1,071,429 (an increase of $71,429 in the price or approx. 7.1%)
Now, let’s go back to the 15% capitalisation rate, but assume that the business broker has applied a $50,000 adjustment to the figures.
Therefore, the Adjusted Net Profit has increased to $200,000. The price is now as follows:
Price = $200,000 / 15% = $1,333,333 (an increase of $333,333 or approx. 33.33% in the sale price!)
As you can see, while the capitalisation rate is important and will impact on the sale price of the business, the adjustments to the figures can sometimes have a much bigger impact!
Therefore, whenever assessing and reviewing a business to buy, make sure you pay very close attention to the adjustments that have been made by the business broker. Consider how reasonable and sustainable the adjustments are.
Also, when looking to sell your pharmacy, it is important to pay close attention to the adjustments required for your business, not just the capitalisation rate applied.
Remember, the point of the adjustments to the figures is to get to a Future Maintainable Earnings of the business. That is, what is going to be the likely net earnings of the business moving forward (into perpetuity).
If you have any questions about capitalisation rates vs adjustments, please feel free to call me on 1300 ATTAIN (288 246). I look forward to discussing with you further.
