Understanding Asset-Based and Income-Based Valuation in Shoe Store Transactions
By Alan Miklofsky, 10/12/24
When it comes to buying or selling a shoe store, understanding how the business will be valued is essential. Two commonly used valuation methods are asset-based valuation and income-based valuation. Each approach serves a different purpose, and knowing the difference can help sellers set realistic expectations and ensure buyers feel comfortable with their investment. Below, I’ll break down these two methods and their implications for shoe store transactions.
Asset-Based Valuation
This method focuses on the net worth of the tangible and intangible assets of the business. Simply put, it calculates the value of a shoe store based on what it owns, minus what it owes. In an asset-based valuation, the primary goal is to determine how much the assets would be worth if the business were sold off or liquidated today.
Key Components in a Shoe Store Asset-Based Valuation:
Inventory: The value of the current stock of shoes, accessories, and any other sellable goods.
FFE (Furniture, Fixtures, and Equipment): Store furniture, shelving, displays, point-of-sale systems, and other equipment used to operate the store.
Real Estate or Lease Value (if applicable): In cases where the store owns its location, real estate is factored in; otherwise, lease agreements can influence the valuation.
Accounts Receivable and Cash: Any outstanding receivables or cash balances are also included.
An asset-based approach is often used when the store’s profitability is low or inconsistent, but its assets still hold considerable value. For instance, if a shoe store has a high inventory balance but struggles with profitability, the buyer may focus on asset value rather than income potential.
Income-Based Valuation
The income-based approach takes a different view by focusing on the business’s ability to generate future income. In this method, the valuation is determined using a multiple of the store’s earnings, typically EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
How Income-Based Valuation Works:
EBITDA Calculation: The first step is calculating the business’s normalized earnings, excluding non-cash expenses and financing costs.
Applying an Industry Multiple: A multiple (usually between 3x to 5x EBITDA, depending on the industry and market conditions) is applied to the earnings to determine the business's value.
For example, if a shoe store generates an annual EBITDA of $200,000 and the typical multiple for similar businesses is 4x, the store would be valued at $800,000.
This approach is ideal for stores with stable earnings and growth potential. It emphasizes the store’s profitability and the buyer’s ability to earn a return on their investment over time.
Which Valuation Method Should You Use?
The choice between asset-based and income-based valuation depends on the circumstances surrounding the sale:
Asset-Based Valuation may be more appropriate if:
The store’s earnings are unstable or minimal.
The primary value lies in the store’s inventory or equipment.
The buyer is more focused on acquiring assets than future earnings.
Income-Based Valuation may be more relevant if:
The store has a solid track record of profitability.
The buyer is interested in the income potential and future cash flow.
The seller wants to capitalize on the business’s earnings history.
Conclusion
In many shoe store transactions, a combination of both asset-based and income-based valuation methods is used to arrive at a fair price. For example, the buyer might start with an asset-based valuation to ensure the inventory and equipment are properly valued, and then apply an income-based approach to account for the store's earnings potential.
Whether you’re buying or selling a shoe store, understanding these two valuation methods helps set realistic expectations and ensures a smoother transaction. A knowledgeable approach to valuation will benefit both parties by providing transparency and fairness throughout the negotiation process.