What Is a Retail Business Worth? How to Estimate Value.

By William Bruce

As a business broker and appraiser, I’m often asked what a retail business is worth. The appraisal of these businesses is not an exact science but there are guidelines and rules-of-thumb that can be used for a close approximation of value.

Certain situations require a formal business appraisal including the larger merger-acquisition transactions, SBA loan applications, management performance tracking, estate planning, divorce — or the most dreaded of all — IRS issues. After all, a professional, fully documented appraisal certainly takes the guesswork out of the situation.

However, what we’re talking about here is not a formal appraisal but rather the informal methods of quickly approximating the value of a retail business.   The guidelines we’ll quote are averages derived from hundreds of completed transactions reported to regional and national databases.

There are two methods of quickly approximating the value of a business: (1) applying a multiple to the discretionary cash flow of the business and (2) applying a percentage to the annual gross revenue of the business.

The most accurate of the two methods seeks to approximate the value of a business by applying a multiple to the company’s discretionary cash flow.

What is discretionary cash flow? It is NOT the profit or loss that you show Uncle Sam on your tax return. To put it delicately, almost all business owners run some expenses through the business that are not — a’hem – absolutely necessary to the operation of the business.

Discretionary cash flow is the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses. Another way to define discretionary cash flow is that it is the “total owner’s benefit”
derived from owning the business, regardless of how the owner takes the money out of the business. It is the amount of cash left over after only the necessary expenses that is available for (1) owner’s remuneration, (2) return on investment and (3) debt service, if any.

If you’re not sure of how to calculate discretionary cash flow, an accountant or professional business broker can compute it for you.

Practically all retail businesses will appraise for somewhere between 1.5 to 2.2 times discretionary cash flow. Exactly where in this range that a specific business will fall depends on the size and type of the retail shop plus its revenue trends.

The second method of estimating the value of a business is less accurate. This method applies a percentage to the operation’s annual gross revenue to approximate value. This method of appraisal assumes the business is earning the average bottom line profit for its peer group. That’s a big assumption!

But making that assumption, we know that almost all retail businesses will appraise for somewhere between 15 and 35 percent of gross annual revenue.

None of these appraisal guidelines include the value of any  inventory on hand or real estate.  If the business owns real estate, the value of the realty should be added to the guideline result. And inventory, at cost, should also be added to obtain the total estimated value of the business.

However, you as the owner, seller or buyer of the business are the final arbiter of what the business is worth to you.  Remember, these guidelines are only averages. And the guidelines certainly don’t take into account any special considerations or any future plans that an owner might have for the business. What a particular business might be worth to you may be more or less than it’s worth to the next person who looks at it.

Here are additional articles that might be of interest: How to Analyze a Business You’re Considering BuyingHow to Make a Written Offer to Buy a Business and How to Handle the Due Diligence Investigation When Buying a Business.

If you have questions about business valuation, please contact me at (251) 990-5934 orWilliamBruceOnline@gmail.com.  In addition to estimates of value using rule-of-thumb guidelines, we also do written, fully documented business appraisals for banks, business buyers and sellers, minority / majority partners and others.

In our practice, we also provide nationwide consulting services to individuals who are considering buying or selling a privately held business.

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William Bruce is available nationally as a consultant on retail business valuation and the issues involved in the transfer of ownership. He may be reached at (251) 990-5934 or by email at WilliamBruceOnline@gmail.com.

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About William Bruce

President, American Business Brokers Association / Business Broker and Accredited Business Intermediary assisting business buyers and sellers with the transfer of ownership / Author: How to Buy a Business.
This entry was posted in Business Valuation & Appraisal, Buying or Selling a Business and tagged , , , , . Bookmark the permalink.

7 Responses to What Is a Retail Business Worth? How to Estimate Value.

  1. Lynne says:

    Would this valuation also include the POS System, and the displays? Or would that be added as a seperate line item?

    • Lynne, thanks for dropping in. The valuation formulas include furniture, fixtures and equipment. Only inventory and real estate (if any) would be added after using the rule-of-thumb formula.

  2. I’m surprised by the 1.5 to 2.2 multiple. You’re basically saying that the buyer will recoup the full investment in 2 years. Isn’t that a bit low? Is this because the type of business you’re talking about requires the owner to manage it continuously and thus a lot of the cash flow actually goes to paying the owner (or a hired manager) a full-time salary instead of repaying the investment?

    • Pedro, Thanks for stopping by. The multiple of discretionary cash flow as a guideline for valuation of retail establishments has historically been lower than for other types of businesses such as manufacturing. Don’t forget that the value of inventory, at cost, is added to the result.

      • Adding the inventory at cost makes sense but that’s a totally different transaction. I’m just wondering what justifies the lower multiple. The only thing I can come up with is that you’re not including the salary of the manager as a cost and thus the discretionary cash flow has to pay for the buyer’s time and not just his capital. Does that sound right?

      • Actually, in calculating discretionary cash flow, the hired manager’s or owner’s salary is included in all categories of businesses, not just retail. So because it’s adusted for universally, this would not account for the lower multiple in retail. One reason that the multiplier is lower in retail is because, generally, there is not as much equipment required in retail as in other types of businesses such as dry cleaning and manufacturing. The multiplier quoted in the article is the averaged result of several thousand retail business sales with the marketplace accounting for the lower cost of equipment required in retail. Hope this helps.

      • >One reason that the multiplier is lower in retail is because, generally, there is not as much equipment required in retail as in other types of businesses such as dry cleaning and manufacturing.

        That makes a lot of sense. Once you’ve taken out the inventory and the location as separate transactions the pure business side of it is much easier to replicate in retail than in other industries.

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