How can you adjust the cash flow of a franchise resale to account for owner benefits and expenses?

1 What are owner benefits and expenses?

Owner benefits and expenses refer to the non-operating or discretionary items that the current owner of a franchise resale includes or excludes from the income statement. These can be impacted by the owner's lifestyle, tax strategy, or personal preferences and are not necessary for the normal operation of the business. Examples of owner benefits and expenses may include salary or wages paid to the owner or their family members, personal expenses such as travel, entertainment, car lease, or insurance, non-recurring costs such as legal fees, repairs, or renovations, depreciation and amortization of assets or goodwill, interest payments on loans or debts, and taxes paid by the business.

2 Why do you need to adjust for owner benefits and expenses?

The reason why you need to adjust for owner benefits and expenses is to determine the true cash flow of the franchise resale, which is also known as the seller's discretionary earnings (SDE). SDE is the amount of money that the owner can take out of the business without affecting its performance or growth. SDE is the basis for valuing a franchise resale, as it represents the potential income and return on investment for a buyer. By adding back the owner benefits and deducting the owner expenses, you can arrive at a more realistic and comparable figure of SDE for a franchise resale.

3 How do you adjust for owner benefits and expenses?

The process of adjusting for owner benefits and expenses is not complicated, but it requires careful analysis and documentation of the income statement of the franchise resale. To begin, start with the net income or profit of the franchise resale, which is the bottom line of the income statement. To this figure, add back any owner benefits that are deducted from the income statement, such as salary, personal expenses, depreciation, interest, or taxes. These are items that increase the cash flow of the business but are not related to its operation. Subtract any owner expenses that are added to the income statement, such as non-recurring or one-time expenses. These are items that decrease the cash flow of the business but are not related to its operation. To ensure transparency and fairness in valuation, verify and justify each adjustment with supporting evidence like receipts, invoices, contracts, or tax returns. Finally, calculate the total SDE by adding or subtracting all the adjustments from the net income.

5 How can you use SDE to value a franchise resale?

Once you have adjusted for owner benefits and expenses and calculated the SDE of a franchise resale, you can use it to value the business. The most common method to value a franchise resale is to apply a multiple to the SDE, which reflects the market demand, risk, growth potential, and profitability of the business. The multiple can range from 1 to 5 or more, depending on various factors, such as the industry, location, size, reputation, competition, and performance of the franchise resale. To determine the appropriate multiple, you can use comparable sales data, industry reports, or professional appraisers. The final value of the franchise resale is the product of the SDE and the multiple.