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How to Calculate ROI Before Buying a Business

June 26th, 2020Small Business Resources

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Founding a startup company can lead to excitement and rewards. On the other hand, if you want a way to own a small business with all of the rewards and a little less excitement, you might consider buying an existing business. If you buy the right company, you should already have a customer base, revenues, employees, equipment, and an effective business model on the first day.

How to Calculate Your ROI When You Buy an Existing Business

To ensure you’re investing in a good business, you should learn how to carefully calculate the business ROI. ROI calculations are pretty simple, but ferreting all of the information you need to perform the calculations may not be. This means you need to learn which questions to ask and how to verify answers.

These suggestions can help you figure out the real returns you can expect from an existing company before you write a check or apply for a business loan:

Should You Allow for an Owner’s Salary?

Most owners plan to run their companies as the manager or CEO. If so, they may plan to pay themselves a manager’s salary. For very small businesses, this income may consume a large part of the profits. You want to use ROI calculations to understand the returns that you can enjoy from your business investment. Still, you might wonder if you should include your own salary as part of the profits or as an added expense.

Different advisors have different opinions about which side of the equation to include the owner’s salary for managing the business on. Your business goals may help you decide how to treat the manager’s salary that you will pay yourself:

  • If you plan to grow the business to sell it at a profit in the future, you might want to treat this salary as an expense. In this case, you’re mostly interested in the company’s value. Also, you will get a clearer picture of how profitable the company would be if you weren’t in the picture.
  • If you plan to manage the company for decades and then pass it on to your heirs, you might leave the salary out of your expenses. Your main reason for investing in the company is as a way to generate income. You just want to be certain that your company can pay your salary and may not care about additional profits as much.

In either case, both the salary and the profits benefit you as a small business owner. Remember that these different ways to take an income may impact both your personal and business taxes. It’s probably best if you can run your calculations both ways, especially if you are comparing different businesses that you might hope to buy to determine which one will benefit you the most.

Calculating ROI Before You Buy a Business

Typically, calculating ROI only involves simple math. You simply divide profits by expenses. For instance, if you spend $100,000 to earn $40,000, you have an ROI of 40 percent. Of course, this figure is much more reliable if you use it to calculate a business ROI that you already control. If you’re trying to figure out the value and returns from an existing business that seeks a buyer, you may have to rely upon information that you get from the current owner.

This isn’t meant to imply that you can’t find reliable and honest business owners. You should just remember that the existing owner is also an eager seller. Even the most honest owners may neglect to account for all expenses because they may not have done a great job of tracking ROI in the first place. If you have the training and experience to properly value an existing company, you’ll know that you need to request tax returns, bank statements, and accounting ledgers from the past few years.

If not, you might hire consultants to help you. These professionals may be accountants or other financial professionals with the skills and experience to guide you properly. Even if the current business doesn’t provide the returns you may have hoped for, business consultants might also provide you with some simple guidance that can help you cut costs or enter new markets.

What’s a Good ROI to Expect From a Small Business?

Large corporations might enjoy great success with an ROI of 10% or even less. Because small business owners usually have to take more risks, most business experts advise buyers of typical small companies to look for an ROI between 15 and 30 percent. Of course, If you decide to take a salary from your business, you may not need an ROI of 15 percent, but you still need to consider how you could profit from your business if you decided you did not want to run it any longer.

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