This is probably the most frequently asked question that we receive. The answer requires a modest amount of analysis on your part, so we have prepared a FREE Excel template that will help you quickly come to an answer. However, this service is available on through your distributor trade association. Please go to their website which will link you to our business valuation model. If your association does not have the linkage, ask them to take part. As fast as you want to. The real question is how fast can you grow without running having to go back to the bank and borrow more money. This can be evaluate fairly easily using what is called the Growth Potential Index (GPI). The GPI provides an estimate, although a good one, of the rate of sales that can be maintained without having to add debt. If you take part in the PAR or PROFIT Reports, we calculate this for you automatically. Please check your Profit Improvement Profile. If you do not take part, you can use the following formula:
Net Profit After Taxes
Accounts Receivable + Inventory - Accounts Payable
The logic is that the after-tax profits represents the money available for growth. The denominator is a working capital model that identifies what additional funds will be required as the firm grows. The result is a percent which reflects the rate of growth that can be maintained without having to incur debt. The best way to make the number higher is to increase bottom-line profits. We view this issue as more of a non-financial issue than a financial one, even though there are some obvious financial implications. The work that we have done in analyzing distributor profitability indicates that there is no measurable impact on financial performance associated with either leasing or owning. Firms that lease their facilities avoid the sizeable investment associated with ownership. However, the landlord must produce an adequate return on investment, so the firm pays a somewhat higher rent. The overall impact on return on assets for the operating company is negligible. There are numerous financial issues beyond return on investment that could be considered. These include the appreciation potential of the distribution facility, how financing the facility will impact financial leverage, and a myriad of tax considerations. While these issues make every situation different, it remains true that owning or leasing has no impact on financial performance. Most of the real reasons to chose leasing or owning are non-financial. For example, rapidly-growing firms may desire to invest exclusively in inventory and accounts receivable. In fact, rapidly-growing companies may not be able to invest in physical facilities even if they wanted to. Similarly, many firms desire the flexibility that leasing provides in terms of expansion potential and changing locations as market conditions change. On the other hand, many firms prefer the control that is only provided through ownership. In addition, as the physical facility is paid off, it represents a potential source of emergency financing in the face of financial challenges. While every firm is unique and different, there is one recurring theme among small to mid-range distribution organizations. Overwhelmingly, these firms own the distribution facilities outside of the operating company and then lease them back to that company. In this way the ownership group can enjoy the tax advantages from depreciation, can reap the benefits of any long-term appreciation of the physical facility and can avoid double taxation. If the rent is based upon an arms-length transaction (which it must be to avoid IRS scrutiny), the impact on the operating company is non-existent. Send it in, we will try to answer it.
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