Two plumbing businesses generate identical revenue, yet the less profitable one might sell for more. How is that possible?
Understanding how to value a trades business requires more than comparing profits. A buyer wants to know what the business can earn without its current owner.
Two Plumbing Businesses, Same Revenue
Consider two plumbing businesses, each generating $450,000 annually, excluding GST. Business A spends 15% of revenue on employee wages, while Business B spends 25%. Both figures exclude owner remuneration.
Business A therefore appears to enjoy a $45,000 annual staffing cost advantage. However, the figures conceal an important difference.
Business A’s owner handles complex jobs, prepares quotes and maintains key customer relationships. Business B employs an experienced supervisor and tradespeople who manage most daily operations.
Suppose replacing Business A’s owner’s duties would cost another $55,000 annually. Its apparent $45,000 staffing advantage would disappear, with replacement costs exceeding that difference by $10,000.
This doesn’t automatically make Business B more valuable. Other expenses, profitability and the owner’s existing remuneration must also be considered. However, it demonstrates why lower wages don’t necessarily mean higher sustainable profits.
What Are the Wages Actually Paying For?
A higher wage bill doesn’t automatically make a business more valuable. It might reflect inefficiency, poor productivity or excessive staffing. Equally, lower wages may conceal the owner’s substantial unpaid or underpaid contribution.
This raises an important question: how much would someone charge to replace the owner’s work? An owner might receive a salary, dividends or shareholder drawings. However, these payments don’t necessarily reflect the commercial cost of replacing their services.
A buyer must consider both the owner’s remuneration and the work they actually perform. Otherwise, the business’s reported profit may give a misleading impression of future earnings.
Experienced employees can also provide continuity after a sale. They may retain customer relationships, supervise apprentices and manage daily operations. However, their contribution depends on whether they remain with the business.
Understanding how to value a trades business therefore requires examining sustainable earnings, not simply reported profit.
The Hidden Cost of Undeclared Cash Jobs
Undeclared cash income can also reduce what buyers offer for a trades business.
Cash payments are perfectly legal. However, Inland Revenue requires businesses to declare cash income just like any other business income. Problems arise when jobs never appear in the accounts or tax returns.
Suppose an owner claims the business earns another $40,000 annually from unrecorded cash jobs. The owner might expect a buyer to include that income in the sale price.
But how can the purchaser verify them? Without reliable records, a buyer may simply refuse to recognise those earnings.
There is also a more serious concern. Undeclared income can create unpaid tax, penalties and additional risks during due diligence. These problems could reduce an offer or even derail the sale.
Proper records protect more than tax compliance. They help demonstrate the genuine earnings a purchaser is being asked to buy.
Owners with historic omissions should act before marketing the business. A voluntary disclosure to Inland Revenue before any audit notice can substantially reduce penalties.
Timing matters.
In a share sale, the buyer inherits the company’s tax history. Expect them to seek warranties, indemnities or a retention from the price. Correcting the records first protects both the sale price and the settlement.
What Determines the Value of a Trades Business?
Revenue establishes the size of a plumbing business, but not necessarily its value. Buyers also assess the quality and reliability of future earnings.
Consider a business that earns much of its revenue from one large building contractor. Losing that relationship could significantly affect future income. By contrast, regular maintenance contracts may provide more predictable work. A broader customer base can also reduce dependence on individual clients.
Vehicles, equipment and specialist tools are another consideration. Their condition, ownership and associated finance commitments can affect a buyer’s assessment.
The buyer’s circumstances matter too. An established plumbing company might already have staff and equipment available to absorb additional work. A first-time purchaser may need to invest heavily in both.
Consequently, different buyers might offer different prices for the same business.
Understanding how to value a trades business requires examining these factors alongside sustainable earnings. No standard revenue multiple can capture every consideration affecting its sale price.
Understand the Business Behind the Numbers
Before selling, consider how much your business depends on you personally. Could it maintain its customers, operations and profitability without your daily involvement?
Understanding how to value a trades business also requires reliable financial records and realistic future earnings. Your accountant can help identify weaknesses worth addressing before you decide to sell. Improving those areas today may also make your business stronger tomorrow.
