The Profit / Revenue/ Account Method

1. The Profit / Revenue/ Account Method 1. Introduction: - This method of valuation is applicable to special properties such as hotels, cinemas, theatres, sports and petrol stations. - Wholly or partly dependent on a capacity to earn income on occupation on the property - The calculation requires the estimation of the average annual gross earnings of the property and the deduction from this figure of the working expenses (excluding rent) and an amount for the occupier’s remuneration, including interest on the capital he has tied up in the business. The balance represent the amount available for annual rent, which is then capitalized by an appropriate Years Purchase to arrive at capital value.

2. The Profit / Revenue/ Account Method 2.Valuation from the account: The actual accounts provide a basis for the assessment of sales income and the operating expenses. The surplus can then be considered. Out of it, the operator will require: a. a return on any capital invested in the business, e.g. furniture and equipment and working capital, i.e. stock and cash float; b. a remuneration for his/her own services and entrepreneurship and business acumen. The balance will represent the likely rental bid of a prospective tenant. Account will have to be examined critically to judge: a. whether they represent the performance of a reasonably capable trader; b. whether adequate allowances have been made for the various expenses; c. whether any unusual items or conditions have affected the account for the year under consideration; d. whether the expenses are all properly allowable in an assessment of notional rental value.

3. The Profit / Revenue/ Account Method 3. The stages involved: a. Calculate Gross Revenue: - examination of gross revenue which provides the valuer with some basic information regarding trading performance - Look at minimum period of 3 years., to see the trend and estimate an average expected return. - Te valuer’s experience of the type of operation will enable him to judge the validity of the figures, and whether more effective methods and marketing could improve the turnover. b. Calculate Net Revenue: - the normal running expenses of the business e.g. wages, fuel bills etc., are deducted from the gross revenue to produce a total net profit. - consider over a period of several years to determine whether there are inefficiencies within the business.

4. The Profit / Revenue/ Account Method c. Add back items to the net profit: - Bank or hire purchase interest : whether money is borrowed on mortgage or working capital or any other reason, interest payable should be excluded. Mortgage interest is a return on the land and building, and this will be covered in the amount for rent. The interest on working capital is dealt with separately in allocating the surplus of income over expenditure. - Rent payable - Capital Expenses: to include only revenue expenditure and not capital sum. For example, purchase of plant and vehicle. - Depreciation: businesses are allowed to claim depreciation on building and plant. - Owner’s drawings, entertainment

5. The Profit / Revenue/ Account Method d. Allowance for tenant’s capital: Interest on the capital is an allowable deduction from net profit. Interest on tenant’s capital includes fixtures, fittings, stock and cash. e. Adjusted net profit ( division balance): The adjusted net profit is split to give: - the hypothetical rent that will be paid - the tenant’s remuneration - the split will vary according to the nature of the subjects. As a general rule ( for exam. purpose), it is split 50/50 0r 60/40

6. The Profit / Revenue/ Account Method 4. Example 1 : Calculate the value of a free public ( that is , not tied to brewery) having a bar and catering trade and shortly to be offered on lease. Receipt from the bar and food £ 20,000 Less Working expenses and occupier’s remuneration£6500 Purchase £10,000 Interest on capital of £5000 (furniture, fitting and equipment, £400 £ 16900 stock and cash)allow 8% Profits per annum £ 3100 Assuming that a tenant would be prepared to pay 40% of profit as rent, that is £1240. Hence Rent per annum = £1240 YP in perpetuity at 12 % = 8.334 Capital value = £10334 Say £10,350

7. The Profit / Revenue/ Account Method 4. Examples (cont) : Please refer to the given notes for more examples