This is the first in a series of articles which will enable you to answer the most fundamental of questions: How much is your hotel or bed and breakfast worth?
Protecting the value of your small hotel or bed and breakfast is a primary goal of your business. But, whether you’re new to the lodging business, an experienced innkeeper, or just looking to buy or sell your property, one key piece of information remains critical. How much is your hotel or B&B worth?
Whether your property is located in North America, Europe, South America, or anywhere in the world, the basic factors to consider are largely the same. But how do you begin to calculate the value of a tourism or lodging business? This is the first in a series of articles we will publish, giving you some new and leading edge techniques on how to value a lodging business. In this and our future articles, we will reveal some unique methods to determining the value of your business. Better yet, these methods can also be applied to most small businesses. If you need to articulate the value of your business in purchase or sale negotiations, we will provide some excellent methodologies to quantify the true market value of your property.
If you’ve looked for advice on calculating a price or value for your small hotel or bed & breakfast, there is only sparse information on the internet. Some resources deal only with the value of your real estate. One so-called “Inn Sales Specialist” advocates a method of determining an inn’s market value by dividing last year’s net operating income by a “cap rate” of 9% – 12%. These are extremely short-sighted methods of estimating value. Another highly simplistic method would be to take your net annual profit, and multiply by 14, which is the average price-earnings ratio of publicly traded companies over the last century.
These simplistic methodologies are not without value, however. There is no single way which will lead you to one absolutely correct theoretical value. What you do want to do, however, is try several conceptually sound methods, and then examine the range of results for consistency. Don’t ignore qualitative objective measures either. For example, consider prevailing real estate values in your region, condition and quality, and potential for growth. If you recently purchased your property, consider the price you paid (the presumed market value at the time) plus or minus value-changing modifications that you will implement with your business plan.
So how do we measure the market value of your business? We look to sources that traditional real estate professionals and B&B sales specialists ignore, or don’t understand. We utilize corporate finance techniques, taught at top business schools, but almost never applied to hotel, hostel, or bed & breakfast businesses in the classroom or in practice. These are the same techniques use by stock market analysts to value Fortune 500 companies. In fact these techniques were adapted from advanced shareholder value studies originally developed by an expert while working at JP Morgan Chase, and now is a leading specialist in online hotel marketing. Combining these traditional corporate finance concepts with some new arithmetic, we will show you how to easily compute an estimated market value for your hotel, inn, or bed & breakfast.
The basic formula underpinning our market value computation is:
Market Value = (NI – BV*Ke) / (Ke-G) + BV
Where NI=net income, BV=book value, Ke=cost of equity, and G=growth rate.
We will show you how to use this simple formula to calculate the estimated value of your lodging business. We won’t get bogged down with complicated mathematical proofs. The formula above is rooted in very sound financial theory, which we won’t waste your time by explaining. What we will do is show you how to move quickly past the complicated financial theory, and use simple math in calculating a very useful number: the value of your hotel or B&B.
One quick homework assignment before proceeding to our next article. There are two values you need to come prepared with, net income (NI) and book value (BV). Net income is the annual after tax profit of your business, after considering all relevant business expenses and income taxes. Make sure you adjust your net income figure for any one-time or unusual expenses you may have had during the most recent year. Secondly, book value is the book equity, or invested capital, in your business. How much cash capital do you have invested in your lodging. This includes any original equity investment you have in your property, but does not include capital that you borrowed to invest or purchase assets. Another way to think of book value is to construct a simple balance sheet. Add up the total value of all your assets, then subtract any borrowings or debt used to acquire those assets. What remains is the book equity, or book value, of your business.
Once you have these figures, please look for our next article, where we will explain how to use the formula to compute the value of your business.
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