The value of your pharmacy
In this article, Jason Bradshaw ACA, Director of Corporate Finance with PKF O’Connor, Leddy & Holmes, gives a brief overview of current valuation methods together with factors which can affect the valuation of your pharmacy and briefly outlines ways to increase the value of your pharmacy business. For the purposes of this article, it is assumed that the pharmacy business is a limited company.
Background to valuation
The landscape of the pharmacy profession has changed dramatically over the last seven years with the FEMPI reductions, economic recession and, most recently, the introduction of Reference Pricing. However, against such a challenging environment, it is a perfect time to refocus on the strategic direction of your pharmacy, including maximising the value of your pharmacy business.
Let us be in no doubt that your pharmacy is a business and, as such, it needs to be treated in the same way as any other business. So, what is the key to increasing the value of your pharmacy? The key to increasing the value of your pharmacy in one word is “Profitability”. The key to increasing profitability is for you to prepare a business development plan for your pharmacy where you can set your goals, targets and objectives.
Basis of valuation
Pharmacies are no longer valued on multiples of turnover but are now valued on a multiple of maintainable EBITDA (Earnings Before Interest Tax Depreciation and Amortisation). This valuation method now brings the pharmacy model into line with the way most other businesses are valued. This is now the most common way to value a pharmacy in that it will give the most accurate reflection of projected cash flow for the business.
In order to calculate the maintainable EBITDA of a pharmacy you must estimate what you think the future EBITDA of the business will be. Factors that need to be taken into account include the impact of Reference Pricing on turnover, gross margin, other sales trends, sustainability of current overheads and adjustment for any excess salary or rent payments to Directors. Any other factors that may affect the profitability of the business must also be taken into account, e.g. the opening of another pharmacy or the opening of a new Primary Care Centre in your locality.
After adjusting for all of the above items, you will derive a maintainable EBITDA figure. It is this maintainable EBITDA figure which is then subject to a multiple in order to arrive at a valuation for the goodwill for your pharmacy.
”The key to increasing the value of your pharmacy in one word is “Profitability”. The key to increasing profitability is for you to prepare a business development plan for your pharmacy where you can set your goals, targets and objectives.”
The multiple applied to maintainable EBITDA can range from 0-10 but in the current banking environment, a multiple in excess of seven times would be difficult to justify. There are numerous factors that you need to consider when assessing the valuation multiple, which are set out below:
- Turnover level
- Sales Mix
- Gross Margin
- Wage costs
- Rent and other overheads
- Future growth potential
- Impact of Reference Pricing
- Future Profits and cash generation from the business
- Competition, including potential new openings
- Proximity to doctors
- Nursing home accounts
- The establishment of a Primary Care Centre in your locality
There is no magic formula for calculating the earnings multiple but all of the above factors should be considered in assessing the valuation of your pharmacy. It is imperative that you engage the services of a Chartered Accountant who has specialist knowledge of the retail pharmacy sector to advise you in regard to the valuation of your pharmacy.
In addition to the goodwill of a pharmacy business you must also calculate the net asset valuation. The net asset valuation can be plus or minus depending on the Balance Sheet of the pharmacy business. The net asset valuation consists of the tangible assets associated with the business. The tangible assets consist of stock, debtors, cash at bank less all trading liabilities of the company.
When there is a freehold property involved (property assumed to be included in the limited company), it is normal practice to have the property independently valued by a reputable firm of auctioneers. The valuation of the freehold property would also be in addition to the pharmacy goodwill and net asset value.
How do you increase the value of your pharmacy? As set out above, the key to increasing the value of your pharmacy is ‘Profitability’. Profitability can be improved by putting in place a business plan and by using Key Performance Indicators (KPIs) to benchmark your financial performance. All pharmacy owners must continue to focus on increasing the profit levels of their pharmacy. This can be achieved in a number of ways (in summary):
1. Gross Margin – This is one of the key areas where you can add value to your pharmacy. The gross margin should be constantly monitored and regular stocktakes should be undertaken. The gross margin can be increased by improving your purchasing and maximising your discounts from your suppliers. A review of your stock control system and other purchasing methods should be undertaken, e.g. generic purchasing, group purchasing etc.
2. Wages/Salary Costs –This item will probably be your biggest expense and, therefore, a review of the number of current employees, pay rates, rostering, locums etc should be undertaken. A majority of pharmacy staff across the country have already taken a pay reduction in addition to some staff redundancies. There has been a marked reduction in the rates of pay to pharmacists and you must ensure that your salary levels are in line with the current market rates.
3. Rent – There has been a significant reduction in commercial rents in recent times. You should review your current rent charge and compare this to the rents being paid in your locality. If your rent charge appears to be in excess of the current market rate in your area, you should consider contacting your landlord and attempt to renegotiate your rent charge.
4. Other Overheads – All other expense items should be reviewed to assess where savings can be made. Significant savings can be made by, for example, switching utility and telecoms providers.
It is crucial that you are in a position to benchmark your pharmacy’s KPIs against other pharmacies which have a similar sales mix, turnover levels, wage costs etc. It is only when you have the results of your benchmarking report that you can start to compare your pharmacy’s financial results against your competitors. The key to successfully putting in place your business development plan is having access to good quality financial information.
In relation to valuation of pharmacies, the key word is ‘Profitability’. It is essential that profitability is now the cornerstone and focus of each and every pharmacy business. The first step in achieving your desired profitability is to prepare a business development plan.
There is no definitive scientific and correct value that can be placed on a pharmacy. The valuation of your pharmacy will depend on a number of factors, which are outlined above. It is the results from all of these factors which will enable your advisor to value your business.
Finally, it must be reiterated that it is essential for all pharmacy owners to engage the services of a Chartered Accountant who specialises in the retail pharmacy sector. This expertise can provide invaluable advice on the preparation of your business development plan, review the financial performance of your pharmacy and which can benchmark your results and performance against other similar pharmacies.
Jason Bradshaw, Director of Corporate Finance at PKF O’Connor, Leddy & Holmes Limited, specialises in providing advice on business development plans, valuations, merger/acquisition/retirement planning advice etc to the retail pharmacy sector. Contact details: firstname.lastname@example.org / 01 496 1444 / www.pkf.ie.