How to Calculate Cap Rate for a Business

Business Cap Rate Calculator

Results

Net Operating Income (NOI): $0

Capitalization Rate: 0%

function calculateCapRate() { var revenue = parseFloat(document.getElementById("grossRevenue").value); var expenses = parseFloat(document.getElementById("operatingExpenses").value); var value = parseFloat(document.getElementById("businessValue").value); if (isNaN(revenue) || isNaN(expenses) || isNaN(value) || value 10) { analysis = "This is a high cap rate, potentially indicating higher risk or a significant return on investment compared to the market average."; } else if (capRate >= 5) { analysis = "This is a moderate cap rate, common for stable businesses in established markets."; } else { analysis = "This is a lower cap rate, often seen in high-value, low-risk acquisitions or premium locations."; } document.getElementById("analysisText").innerText = analysis; document.getElementById("capRateResult").style.display = "block"; }

Understanding Cap Rate in Business Valuation

The Capitalization Rate (or Cap Rate) is a fundamental metric used by investors to assess the potential profitability and risk level of a business acquisition. Unlike real estate cap rates which focus strictly on property income, a business cap rate accounts for the operational efficiency and net cash flow generated by the company's activities.

The Cap Rate Formula

To calculate the cap rate for a business, you must first determine the Net Operating Income (NOI). This is the amount left over after all operating expenses are subtracted from the total revenue, but before taxes and interest payments are considered.

Cap Rate = (Net Operating Income / Current Market Value) × 100

Key Components Explained

• Gross Revenue: All income generated by the business before any deductions.
• Operating Expenses: Costs required to run the business (rent, payroll, utilities, insurance, supplies). This excludes debt service or personal owner expenses.
• Current Market Value: The estimated selling price of the business in the current market.

Example Calculation

Imagine a local manufacturing company that generates $1,200,000 in annual revenue. Their operating expenses, including materials and labor, total $800,000. The business is currently valued at $4,000,000.

1. Calculate NOI: $1,200,000 – $800,000 = $400,000
2. Divide NOI by Value: $400,000 / $4,000,000 = 0.10
3. Multiply by 100: 10% Cap Rate

What is a Good Cap Rate?

A "good" cap rate is subjective and varies by industry. Generally, a higher cap rate implies a higher potential return but often comes with higher operational risk. A lower cap rate suggests a safer investment in a stable market with lower growth volatility. Most business acquisitions fall within the 5% to 15% range depending on the sector and economic climate.