Day spas are popular personal services businesses. Their number speaks for itself – classified under the SIC code 7231, there are over 325,000 such establishments in the US alone.
The industry employment of 907,250 people is quite large. Day spas and beauty salons contribute over $18B in total annual revenues to the economy. Yet an average business is quite small – employing just 3 staff with $100,000 in annual sales.
Typical spa valuation multiples
If you need to estimate the market value of a spa, consult the recent spa selling price data. Valuation multiples derived from such business sales are the formulas that let you compare your spa to others – based on its revenues, profits, or asset base. Here are the valuation multiples commonly used to price a spa for sale:
- Business selling price to gross revenues. Inventory is extra.
- Price to seller’s discretionary cash flow, plus inventory.
The price to gross revenue valuation multiple is more accurate for valuing a privately owned spa or hair salon. In fact, the spread of business selling prices, from low to high, is about half that of the business value estimates you get using the discretionary cash flow as the basis.
For example, it is not unusual for a spa to sell for about 40% of its gross revenues. Even the top businesses rarely fetch a price that is more than 100% of their annual sales.
In contrast, we see some spas selling for more than 10 times their discretionary cash flow. That can be 4 – 5 times the average – a very considerable spread. One reason is that profitability of a spa can vary greatly for a given level of sales. This, of course, affects the discretionary cash flow the spa can throw off.
What this means is that the actual spa sales are more often priced based on the business revenues.
See how to value a spa by comparison to recent private business sales. Determine the business value based on its gross revenues, net sales, profits, cash flow and assets.
See Example »
Other business valuation methods for spas and beauty salons
No spa valuation is complete without an income-based analysis of your business value. If you are valuing a small owner-operator managed spa, consider using the Multiple of Discretionary Earnings method. You can consider both the earnings and a number of essential performance factors to determine what the business is worth.
For a well-established business, the value of goodwill can be a large part of the overall spa value. You can use the well-known Capitalized Excess Earnings method to determine what the business goodwill is worth.
This may be an important step when allocating the business purchase price, determining what to pay a departing business partner, or handling a business valuation in divorce.
Business Valuation using Several Methods
Wondering how the current economic situation affects business valuation? To gain an insight, let’s take a look at the fundamentals of business appraisal.
Three approaches to business valuation
The value of any business can be measured three ways, known as approaches:
- Market – by comparing the recent sales of similar businesses.
- Asset – by studying the costs associated with business creation.
- Income- by assessing the business earning capacity and risk.
Income-based business valuation – capturing the economic downturn effects
The income approach to valuing a business offers perhaps the best way to assess the effects of the economic ups and downs. The reason is this: all income-based business valuation methods are forward-looking.
Business value is affected by the earnings outlook
In other words, you can calculate your business value based on the business earnings forecast. Needless to say, the earnings outlook will be greatly influenced by macroeconomic factors.
Business valuation and increased risks
In tough economic times, business investment carries additional risk. Your income business valuation incorporates this in the form of discount and capitalization rates. The more uncertain the future, the higher the business risk and the associated discount and cap rates.
The build-up model for calculating the discount rate shows this effect very clearly. In particular, the risk-free return and equity risk premium reflect the macroeconomic environment – something every business is exposed to.
Your company’s risk also needs to be adjusted for the industry-wide factors. These affect all businesses operating in your industry. If the industry is vulnerable as a whole, the business is likely to be impacted as well. This increases the discount rate, lowering your business valuation.
To summarize, an economic downturn is likely to affect your business valuation two ways:
- By lowering the expectation of business earnings.
- By more conservative business risk assessment – which leads to higher discount and cap rates.
Example – how economic downturn can reduce business value
We will use the well-known Discounted Cash Flow business valuation method. As is the case with most professional business appraisals, we use the business net cash flow as the earnings basis. The result is calculated as the Market Value of Invested Capital, the typical value measure in small business appraisals.
Our initial earnings forecast, created before the downturn took hold is as follows:
- First year (2009): $250,000.
- Second year: $275,000.
- Third year: $290,000.
- Forth year: $310,000.
- Fifth year: $335,000.
The company is debt free and we have estimated the equity discount rate to be 25%.
Given the latest developments in the market, we have revised our cash flow projections as follows:
- Year 1: $200,000.
- Year 2: $210,000.
- Year 3: $245,000.
- Year 4: $290,000.
- Year 5: $330,000.
We further conclude that the additional risks have increased the discount rate to 32%.
Using the Discounted Cash Flow method for both scenarios, gives us the following business valuation results:
- Original figures: $1,440,231.
- Revised for ecomonic downturn: $1,060,266.
In other words, the lower expectations of financial performance in the current market have reduced the value of the business by almost $400,000 or 40%!
Business valuations can increase in some market niches!
This, of course, is merely an example. A business can thrive in a down ecomony because it occupies a unique niche in its market.
Businesses and consumers looking to save money may keep their old cars running longer. While the new car dealership may suffer, the auto repair shop may get additional business.
For these companies, the earnings outlook and risk assessment may well paint a very different picture of what each business is worth currently.
Business Valuation based on Income and Risk
One way to value a business is by comparison to recent sales of similar businesses. The typical way to estimate your business value using such market comps is with valuation multiples.
A wide range of valuation multiples to choose from
These multiples are ratios that help you determine your business market value in relation to the company’s financial performance. For example, you can estimate your business worth based on its revenues, earnings, cash flow, EBIT, EBITDA, equity or asset values.
Which valuation multiples are more accurate?
Given the choice of valuation multiples, you may wonder: are some multiples more accurate for estimating your business worth?
Yes indeed! Since the valuation multiples are statistically derived, you can easily assess the accuracy of each – and choose the best.
Range of business values and coefficient of variation
Professional business appraisers pay close attention to the so-called coefficient of variation. It is a ratio of the standard deviation to the average value of a given valuation multiple.
The reason this is important is this: the smaller the coefficient of variation, the closer the actual business selling price multiples cluster around the average.
If you use the valuation multiple with the low coefficient of variation, your business value estimate is likely to be more accurate since it falls into a narrow range.
Another way to look at this is that the business people in your industry tend to price business sale deals using such valuation multiples.
Example: picking a multiple to estimate the value of a restaurant
Let’s take a look at an example. We are looking to estimate the market value of a privately owned family restaurant. The restaurant grosses $1,500,000 in annual sales, throws off $250,000 of discretionary cash flow, has $100,000 of inventory and is located in the Los Angeles area.
The typical choices of valuation multiples for this business are:
- Business sale price to gross revenues.
- Business sale price to seller’s discretionary cash flow.
So which one is the best choice?
We study the sales of privately owned restaurants regularly. The recent numbers show that the coefficient of variation for the above two valuation multiples are:
- Gross revenue-based: 0.554.
- Discretionary cash flow-based: 0.509.
The average multiples will vary with a number of factors, including the restaurant size, location, and specific market niche. A reasonable approximation for our example business is around 0.3 times the gross revenues, and 1.7 times the cash flow, plus inventory.
Here are our estimates for the restaurant market value:
- Gross revenue based – around $550,000 (including the inventory).
- Discretionary cash flow based – around $525,000.
Since the coefficient of variation for the cash flow-based multiple is lower, you should first consider the second restaurant value estimate – in this case $525,000.
If you are valuing a women’s apparel store, there a number of important factors to consider:
Apparel retail business value drivers
- Rental expenses for successful stores are kept to within 10% of the gross revenues.
- Labor costs are a significant factor that contributes to the store profitability and business value. The industry norm is to keep labor expenses under 18% of gross revenues.
- Product costs and gross margins. Successful retailers have their COGS within 50% of sales.
- Product and market differentiation. Many apparel retailers have carved out lucrative niches – with bridal, maternity, men / women product mix, gifts and special occasion offerings.
- Quality of customer service. Often the store’s image and its ability to attract and retain customers depends on the quality of its service staff.
Valuation multiples for womens clothing stores
Owner-operator managed small apparel retailers are frequent acquisition targets. You can use such private business sale comparables to estimate your own business market value. The standard technique is to develop valuation multiples that relate the business likely selling price to its financial performance.
Here are the valuation multiples that your industry peers use most often when pricing a women’s clothing store for sale:
One reason that the apparel stores are mostly priced on business gross revenues is that many buyers make considerable changes to the store after they take over. This is done in order to reduce the operating expenses and improve the business profitability.
Other business valuation methods
You can also value a women’s clothing store using a number of well-known business valuation methods under the market, asset, and income valuation approaches.
Valuing a business as a multiple of earnings
For small retailers the Multiple of Discretionary Earnings method offers a great way to assess your business value based on its earnings and a set of key financial and operational performance factors.
Business valuation based on cash flow and risk
For larger, multi-location retailers, the Discounted Cash Flow valuation method is preferred. Using this business appraisal technique you can determine your business worth based on its earning capacity and risk.
Business goodwill estimation for established retailers
Well-established women’s clothing store command considerable goodwill in their market. You can determine the value of business goodwill using the classical Capitalized Excess Earnings method.
Be careful to adjust the business assets to their market values. One asset that often calls for such an adjustment is inventory. If you carry inventory in excess of 1 year’s worth – reduce it to good and salable levels.
Consider using a number of well-known business valuation methods to create an accurate, defensible appraisal of an apparel retail store.
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