A discount rate is set based on the current cost of capital in the market place adjusted based on factors such as internal and external risks, competition, leverage ability and strategic advantages that would accrue to the buyer as a result of acquiring your business. The discount rate is used to bring the cash flow in each year back to present value, the theory being that a dollar earned in the future is worth less than a dollar earned today. The higher the perceived risk, the higher the discount rate and therefore, the lower the present value will be of estimated future earnings. The value of the business is represented by the cumulative present value of cash flows over the forecast period.

Capitalization of cash flow method: In this approach, you identify the revenues and expenses of the business in current dollars. These revenues and expenses must be normalized-that is, unusual revenues and expenses must be removed and below average revenues and expenses must be increased to levels typically experienced by the business. A multiplier is then applied to the resulting cash flow before debt service depreciation and taxes. The multiplier is set based on the prospects for longer term growth and the risk associated with achieving that growth. Multipliers vary from situation to situation. Typically in the restaurant industry, multipliers range from 2 to 4 times earnings but may be higher for businesses with powerful brand equity and a long-term pattern of success. The value of the business is represented by the product of the normalized net cash flow times the selected multiplier.

Once the value is established, you may have to reduce the value by the cost of any investment required to sustain the anticipated future cash flows.

This brief summary of the standard approach to valuing a business is not exhaustive-there are often other factors that must be considered. Depending on the purpose of the valuation, it may be in your best interest to obtain a professional opinion.

About the Author:

Geoff Wilson is the President of geoff wilson & associates inc. , a consulting firm specializing in business strategy for foodservice operators, facility owners, food processors, foodservice distributors and related parties in order to help them maximize customer satisfaction and return on investment in foodservice and related businesses and facilities. Geoff can be reached at (905) 814-6610 or by e-mail at geoff@gwilsonassocs.com.