How to Find the Capitalization Rate for a Restaurant
The capitalization rate for any new business is the speed at which you can reasonably expect to recoup your cash investment into the business. The capitalization rate for any business is equal to the net annual profit from operations divided by the sales price. You then express the capitalization rate as a percentage, rather than a fraction. For example, a restaurant with annual operating profits of $500,000 that sells for $1 million has a capitalization rating of 50 percent.
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Instructions
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Determine the net operating income for the restaurant. This is the restaurant's free cash profits available from food and alcohol sales -- and in some cases, supplemental retail sales -- after all business expenses and debt payments have been paid. If you are looking to purchase the restaurant, look at the restaurant's balance sheets, the cash flow statements, and the federal income tax returns for the business over the past several years.
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Find an interested buyer, who is willing to name a price. You can estimate a price based on what people have purchased similar restaurants for in your area, but these are very rough estimates only, since no two restaurants are identical.
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Determine the capitalization rate as a function of the net operating income divided by the offering price. The lower the price, the higher the capitalization rate will be, all things being equal. If the buyer perceives the restaurant to be very risky, he will bid the price down, relative to similar restaurants. If the bid is less than the annual operating earnings, the buyer has priced the restaurant's future value as an ongoing concern to be nil, indicating that his assessment of the restaurant is that it is a very risky investment. In the restaurant industry, a cap rate of 20 to 25 percent seems to be the standard for established, stable restaurants, meaning the usual price for a solid, established restaurant is about four to five years worth of operating earnings.
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Tips & Warnings
Occasionally, you may see the term "capitalization" to refer to the practice of deducting your acquisition or startup costs gradually over a number of years, rather than deducting them all in the first year. In this case, you generally deduct startup, acquisition costs and intangible asset costs over a 180-month period. For more information, see IRS Publication 535, "Business Expenses."
