Everybody wants to know if a business makes two, three, or 10 times profit. They hear price-earnings ratios tossed around, and forget that such ratios commonly refer to companies listed on the stock exchange. In small business, such ratios have limited value. A big business can earn 10 percent on its investment and be extremely healthy. The big supermarkets net two or three percent on their sales, but this small percentage represents enormous volume.
Small businesses are different.
The small business should typically earn a bigger return because the risk of the enterprise is higher. The important thing for you, as a buyer of a small business, is to realize that regardless of industry practices for big business, it is the ROI that you need to worry about most. If the price is realistic for the amount of money you have to invest, then you can consider it a viable business. The capitalization rate is determined by learning what the risk of investment in the business would be in comparison to other investments such as government bonds or stock in other companies. For instance, if the rate of return on investment in government bonds is 18 percent, then the business should provide a return of 18 percent or better on the investment into it.