Looking Fit

by Jerry Deveney

Buying or selling. Expanding or just getting started. Understanding what a business is worth in dollars and cents is absolutely essential for effectively handling a variety of important issues that will one day face all salon owners.

However, many salon owners do not fully appreciate the value of their businesses. What many fail to realize is that there is more to a salon than just equipment and inventory.

Whether you are looking to purchase another salon to expand operations, open your first salon or fully insure your existing location, it is important to be able to properly evaluate a business.

Many salon owners have underestimated exactly what they have accomplished and what their hard work may actually be worth. By taking the time to read this article and identify the value of your business, you may gain a new respect for this industry. A respect that may be reflected in the way you handle future business decisions and day-to-day operations.

The factors that contribute the most to the value of a business are (a) construction and build-out, (b) documented earnings, (c) the type, quality and current condition of equipment featured, (d) location and leasing arrangement, (e) size and quality of active clientele and, (f) saleable inventory. Of these, construction and build-out costs often are the most underappreciated and overlooked assets. Included in this category are items such as sheet rock, wood framing, paint, carpeting, flooring, all electrical wiring, air conditioning and duct work, general lighting, signage, furniture, cash registers, computers, timers, decorations and the cost of all related labor.

Based on industry estimates the cost to build-out a typical nine-unit tanning salon can range from $20,000 to $50,000 depending upon the quality of materials used and the cost of labor. The cost of the actual build out will have a huge impact on determining the actual value of the business. It also is something that needs to be fully insured.

The next asset to consider is documented earnings. That is, what income a salon can prove that it actually generates each year. The most reliable source for this information is a tax return. A friend who is a CPA told me years ago that if you ever want to sell a business for what it's really worth you must record and report all of your income.

For example, you can't tell someone that your business really nets $50,000 a year with records that only show a net of $25,000, then expect someone to pay for the full value of the business. A potential buyer may think, "If this guy cheats on his taxes, how do I know he's telling me the truth about his income?"

However, there is a method of estimating what business a salon actually does that can be virtually fool proof. All you need are the salon's electric bills, the type of equipment featured and the length of the average session.

Depending upon the type of equipment featured you can estimate the number of kilowatts of power required to run a tanning unit for each tanning session. Compare that figure to the actual number of kilowatts used by the business and you can quickly estimate how many sessions the salon generates each month.

If the salon can prove that it generates $50,000 in net income each year, this figure can then be used in calculating the actual value of the salon.

Next, let's look at the value of the tanning equipment. For this example we will use a nine-unit salon where the equipment, which originally cost $5,000 per unit, is now three years old. The units have been maintained in good condition and the lamps and acrylics recently have been replaced.

The first step in properly estimating the value of the equipment is to contact the original manufacturer and determine what a similar type unit would sell for brand new.

If a new bed with a similar number of lamps and features would now cost $6,500, you're probably in good shape. However, if anyone could buy the same type bed today for less than was originally paid three years ago, you will need to adjust the equipment value accordingly. In addition, if the manufacturer or importer has since gone out of business the value of the equipment also will depreciate significantly.

Based on our studies most high-quality tanning systems purchased from a reputable company that are maintained and in good working condition will hold their value extremely well. In many cases, the units depreciate about 15 percent each year for the first three years, then maintain about 40 percent to 50 percent of their original purchase price. For example, a tanning unit purchased three years ago for $5,000 might still be worth $2,500 to $3,000 today.

Another factor in determining the value of a tanning salon is the physical location of the business and the type of lease available. For example, you could have a business in an excellent high-traffic location with great visibility, but the landlord only will offer a month-to-month lease. Such a situation could render the business virtually worthless since you run the risk of losing your lease and location with just 30 days notice.

What salon owners should look for in a location is visibility, traffic and parking in an area that also features businesses that will attract potential customers such as supermarkets, dry cleaners, restaurants, video stores, etc.

The length and quality of the lease will play a significant role when evaluating the actual worth of a business. Therefore, it is essential that the lease should be for a minimum of one year, (three to five is preferred), with defined options on renewal and assignability. Any increases in rent must be clearly identified and explained. Any additional common charges also must be understood clearly. The allowable hours of operation should be at the lessees discretion.

The size of your active database is another a valuable asset. The years spent creating the perfect atmosphere and tanning environment is something that no one else can replace. We see many examples where two salons are located in the same town and offer the same tanning equipment. One salon flourished while the other flounders.

Even when the struggling salon lowers prices it fails to generate long-term success. Why? In the majority of situations like this, the success or failure of the business is dependent upon the people behind the counter and their ability to treat customers properly. The rapport and goodwill established is easily recognized by the number of active customers in your database.

Finally, the products that you offer such as lotions, activewear, etc., also may be counted in the value of your business. However, this category must consist of products that have a documented sales history. No one is going to pay you for outdated products or your slow movers.

Based on the major factors identified that influence the value of a business, we can provide a working example for comparison. Let's say that in a salon the build-out cost was $25,000. We can document $50,000 per year in net earnings and we have a solid 3-year lease at a very competitive rate.

We have nine tanning units that are three years old. They cost $5,000 new and a similar type unit today would cost $6,500. The equipment manufacturer is in business and has given written assurance that replacement parts and service are readily available.

Our salon has 2,000 customers is the database of which 1,000 frequent the salon each month during the busiest months of the year. In addition we have $2,000 in top selling, name brand lotions in stock.

By combining the estimated value of documented earnings, ($50,000), build-out ($25,000), equipment, ($22,500 = one-half the original cost), inventory, ($2,000) and allowing $10,000 for location, database and goodwill, this salon may be worth up to $109,500 in a strong market.

A strong market often is defined as one where session pricing is fair and stable, the unemployment rate is low, real estate values are appreciating and the potential customer base is established and growing. In a weak market, where the value of the business depends primarily on income, this business may be worth $60,000.

Based on our studies, many people underestimate the value and the potential of their business. Consequently, they may not devote the necessary attention to the business and sales suffer. Meanwhile, sharp entrepreneurs are always on the look out for a bargain.

A few years ago I witnessed a well established six-bed salon in a good area sell for less than $30,000. The equipment and build-out was worth that much. Within one year the new absentee' owner had netted more than $60,000. That without even changing the original equipment.

While we cannot guarantee the actual dollar value that your business is worth, it's important to take stock in yourself and appreciate what you own and have accomplished.

Jerry Deveney is director of marketing for Sun Industries, Inc. He may be contacted directly at 1-800-643-0086, ext. 114. The figures and calculations used are for comparison only and do not represent a guarantee of income or return on investment.