Other methods – Return on Investment (ROI)
This method considers the rate of return that will be achieved by the investment. It
measures the maintainable revenues of the business against the total investment
required. Unless there are threshold levels below which a prudent investor would not
invest in a business this method provides a comparative rather than a absolute
valuation but is oftentimes used as a Secondary or “reality check” to the primary
methodology.
Whilst there are no absolutes in the SME Australian setting, industry practice
indicates an expectation of the ROI to be in range of 20 – 45 %. A return less than
20% would normally not warrant the risk of an investment in a closely held private
business and a return of over 45% would indicate a risk factor that would be too high
for many small/medium business investors. As a consequence, this method requires
an analysis of the risk / return model of any business.
We will now focus on two methods in relation to ABC Software Solutions Pty Ltd:
Capitalisation of Future Maintainable Earnings methodology detailed:
This method involves an analysis of the past performance of the business, in order to
determine the business’s future maintainable earnings and capitalise those earnings
for an expected rate of return on the investment.
To achieve this the past 3 years Profit and Loss reports and Balance Sheets are
analysed to determine the Net Profit from all Operations. This figure is that presented
to the ATO for determination of Corporate Tax liability.
Whilst this provides an accurate summation of the business activities there are
certain ‘book’ and proprietors discretionary expenditure as well as abnormal ‘one off’
©AVANTIA 2007
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