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Goodwill

Definition

Goodwill is the value of a business, taking into account its reputation, its established client base and its profitability. Most banks do not consider goodwill to be a tangible asset, in the same way that a freehold property is and are therefore reluctant to lend against it without the comfort of other supporting security.

The 1987 pharmacy contract placed a strict limitation on the granting of new dispensing licences and in essence, in order to obtain a new contract, it must now be proved to be desirable or necessary. If there is already a pharmacy serving the neighbourhood then such an application will usually fail unless it falls within one of the following four categories, where the regulations are being relaxed by the government as a result of changes made in 2004.

  1. Where the new pharmacy is to be situated in one of the listed shopping developments. Click here for more information
  2. Where the pharmacy will open for 100 hours per week and provide a full service.
  3. Where the pharmacy will be part of a consortia in a new 'one stop' health centre development.
  4. Where the service offered is over the internet of through mail order.

As a result, pharmacy goodwill values can be substantial and usually comprise the major part of the finance required. Without the support of the AAH/Statim loan guarantee scheme therefore, it would be very difficult, if not impossible, for a pharmacist to raise the necessary funds at reasonable interest rates.

How is the goodwill value established?

The success of a pharmacy business is dependent upon its ability to meet its overhead costs including the capital and interest payments upon the loan taken out to purchase it. It must also provide the owner with a reasonable standard of living and hopefully something extra to provide a return on the investment made.

The goodwill value usually comprises the majority of the total acquisition cost and it is therefore imperative that this is accurately calculated. It should be possible to establish a value within a range of + or - 5%, taking into account the historical profitability of the pharmacy as well as its future potential. However take care not to add in too much for potential. If the existing owner could not be bothered to realise it, why should he receive the benefit in an enhanced goodwill valuation?

One thing that goodwill is not, is a percentage of sales turnover. Sales are certainly one influence on value but there are several others: In particular the mix of sales will influence the gross margin and therefore the gross profit earned by the business.

The overhead costs also have a direct bearing upon what net profit is left after payment of all expenses. These costs, particularly property costs and wage costs can vary widely between different pharmacies and therefore lead to quite different goodwill values for two otherwise similar looking pharmacies. Whilst generally, a multiple of 5 times True Net Profit will provide an accurate valuation, there are factors which might influence a lower or higher multiple:

Factors influencing a lower multiple

  • Low sales turnover (< £400,000 p.a.)
  • Dispensing < 2,000 items per month. (Unless ESP)
  • High OTC (> 40% of the total sales)
  • High proportion of nursing home scripts. (> 20% of the total scripts)
  • Several perfumery agencies.

Factors influencing a higher multiple:

  • High turnover (> £850,000 p.a.)
  • A group of high turnover pharmacies in close geographic location.

These examples are not exhaustive, and the principle to be applied, which does require some subjective judgement, is one of supply and demand. There is greater demand for the larger pharmacies particularly from the multiples and there is much less demand for smaller pharmacies, particularly where competition from other pharmacies is high.

Factors affecting the goodwill value

As stated above the value of the goodwill of any pharmacy is directly based on the true net profit generated by the business and can be calculated as follows:-

Total sales achieved

NHS/OTC split

OTC Gross margin is higher than dispensing gross margins.

NHS split

Generally the margin on generic drugs is higher than on branded drugs.

Cost of sales

Dependent upon stock management & buying policy. Is full use made of supplier discounts?

Gross profit

The difference between total sales and cost of sales.

True overhead costs

Pharmacist manager

Typical salary £35-40,000 p.a. + NIC depending upon the location, for a 40 hour week. Allow for additional pharmacist cost for longer hours or high prescription levels. The true cost is allowed for even if the owner will work for less.

Staff wages

In the region of 5% of the sales turnover.(Higher if OTC sales > 25% of total sales - Lower if OTC sales < 10% of total sales)

Locum cover

Allow min. £5,000 for average 6 weeks p.a.

Property cost

Either the shop rent or a notional rental figure of 10% of the freehold value where the freehold is owned. Plus the property business rates payable.

Other sundry costs

Typically these will amount to c.2% of the sales turnover covering, heat & light, audit fees, repairs, postage, subscriptions, telephone, insurance & stocktaking etc.

True net profit

Gross profit less the true overhead costs referred to above. Omitted from the overhead costs are: Motor expenses (unless specifically for collection & delivery) Interest charges and pension contributions. These costs are specific to the owner, rather than the business.

Goodwill value

Generally a multiple of 5 times the true net profit but can vary depending upon individual circumstances.

In order that the calculation of goodwill value is as accurate as possible, always use the most up to date, verifiable, information available.