A GAP analysis is a technique to help you, the business owner, assess where you are, where you want to be, and the distance in between. In general, there are three basic steps to a GAP analysis.
1. Assessment
2. Diagnosis
3. Recommendations
For the business owner, the assessment includes both understanding where the business is and where you want to be personally. Most business owners consider retirement as their number one personal goal.
Business Assessment
The business assessment starts with understanding precisely where the business is. This is usually performed using a benchmark analysis. The purpose of benchmarking is to compare the financial performance of a company to similar types of companies, in terms of both industry and company size. Here is one definition of benchmarking:
Benchmarking is the process of continually comparing and measuring your products, services and practices to improve performance. The key first step in benchmarking is understanding where a company “stands” in terms of that performance within the spectrum of performance.
The benchmarking process provides an indication of where a company is strong and where improvements need to be made. We assume that all firms are unique and have different operating and financial characteristics. Nonetheless, comparing against industry norms can be useful in identifying possible problem areas before they get out of hand.
The benchmarking process is started by developing a profile of financial performance, including extensive ratio analysis as well as identifying areas of strengths and weakness. Benchmarking also includes developing ideas to improve those areas. By concentrating on primary areas needing improvement, management makes the most efficient use of limited time and resources. Continuous improvement is the natural outgrowth of competitive benchmarking and can be accomplished with various methods. Below are few of the more common methods:
• The DuPont Model
• SWOT Analysis
• Ratio Analysis
• Z-Score
There are many applications for benchmark reports and, to a large extent, benchmarking depends on the nature of management’s current objectives. Profit Improvement, Strategic Planning, Obtaining Financing, and Reducing Costs are a few of the traditional objectives.
Additionally, benchmarking helps the business owner and management begin the succession planning process and increasing the likelihood that the business will succeed when the owner is no longer involved, reducing the business’s reliance on the owner.
When the value of the business no longer depends on the owner, he or she can choose to retire without diminishing the value of the business. Therefore, performing a valuation analysis is a crucial part of the business assessment.
The topic of business valuation will not be discussed now, but look for it in a future article. It is a very important topic and deserves an entire article to properly introduce the subject.
Personal Assessment
Now we can turn toward the personal assessment and strategically plan for retirement through a multi-discipline planning process including:
• Financial planning for owner and family (and the business if not previously addressed)
• Estate planning for the owner
• Tax reduction strategies
• Funding the sale of the business
The owner’s goals shape the succession plan. Therefore, it is critical that the owner be able to articulate his or her personal goals as well as goals for the family and the business.
Diagnoses
Through the financial planning process, two main objectives are discovered.
1. How much income is needed to support the post-business life style?
2. What is the required rate of return to support the desired level of spending based on the after-tax proceeds received from the sale of the business?
The calculation of these two questions is beyond the scope of this article; however, let’s go through a brief example to illustrate.
Desired Retirement Income in today’s dollars $100,000
Required Rate of Return (preservation of capital)
Net Spending Rate 4%
Inflation 3%
Subtotal 7%
Adjust for taxes
At 30% .7 (1-Tax Rate)
Final calculation 7% divided by .7 = 10%
Required rate of return 10%
Required capital to provide $100,000 per year adjusted for taxes and inflation: $1,000,000
Business Value (calculations not shown) $400,000
Business value minus Retirement Capital Required = Surplus or short fall
$400,000-$1,000,000 = -$600,000 (short)
Closing the GAP
If there is a GAP between what you want and what you have, your attention must turn toward closing the GAP. Closing the GAP can be done in a positive proactive process by decreasing risks and/or focusing on increasing cash flows. Or you can adjust your goals downward by delaying retirement and/or reducing the amount of money you will spend in retirement.
To summarize, properly performing a GAP analysis will help you build a road map to:
• Create/Maximize Business value
• Control your business
• Help you to understand where you are and where you want to be
Want to learn more? Sign up for our April 26 Biz-Well workshop in Seattle.
To your success,
Joe Maas, CFA, AVA, CFP®, ChFC, CLU®, MSFS, CCIM
President of Synergetic Finance
