Business valuation tips, updates and advice. Pick up a few suggestions on how to value a business. Feel free to browse the contents or share your thoughts by leaving a comment.
If you need to value a business based on comparison to recent sales of similar companies, carefully selected valuation multiples are the tools to use. The multiples help you estimate your business value based on the company’s financial performance and actual selling prices of firms in your industry sector.
Since no two businesses are the same, your comparison should be based on a data set of companies that closely resemble the business being valued. You can calculate a number of valuation multiples based on each firm’s actual selling price and financial parameters.
To make these multiples useful for your business value estimation, you would need to do some statistical analysis. The typical format used in professional business appraisals under the market approach is this:
Calculate the low, median, average and high values for each selected business valuation multiple.
Apply each valuation multiple to the subject business financial parameters to come up with a business value estimate.
Use your results to establish a range of business values or average them to report a single number.
Example – using valuation multiples for a private food manufacturing business valuation
To demonstrate the idea, we select a number of valuation multiples to value a small privately owned food manufacturing firm:
Multiple
Low
Median
Average
High
Weighted average
Price to net sales
0.08
0.40
0.76
4.81
1.51
Price to gross profit
0.43
1.11
2.06
13.48
4.27
Price to EBITDA
1.24
2.16
3.99
11.33
4.68
Price to Total Assets
1.00
1.76
3.16
12.78
4.68
Our example business has these financial parameters:
Business annual net sales of $305,281.
Gross profit of $170,353.
EBITDA of $40,248.
Total business assets valued at $150,466.
Next, we use the weighted average figures for each valuation multiple to come up with the business value result:
Multiple
Multiple value
Business value
Price to net sales
1.51
$460,974
Price to gross profit
4.27
$727,407
Price to EBITDA
4.68
$188,361
Price to Total Assets
4.68
$704,181
This gives us the average business value estimate of $520,231. Alternatively, the business value lies somewhere between $188,361 and $704,181. This type of range is not unusual and can be used to pinpoint the firm’s strengths and weaknesses compared to its competitors.
Our example firm appears to be asset rich, has above average gross margins, but under-performs in terms of profitability.
Valuation multiples lie at the heart of business valuation under the market approach. Each business is different. Yet businesses in the same industry group, of similar size and ownership structure may share a number of important factors that drive their value.
If there are enough data on similar business sales, you can estimate the value of a company by comparing the recent business selling prices. Valuation multiples are ratios that relate the business selling prices to their financial performance. This relative measure of business value lets you calculate the worth of a similar business even if it has never been put on the market.
List of valuation multiples used
Professionals use a number of valuation multiples in their business appraisals. Here is the most common list, grouped by category:
Business valuation multiples based on revenue
These types of multiples are very common in valuations of professional practices and rapidly growing businesses.
Business price to gross revenue.
Price to net sales. Net sales are gross revenues less returns and discounts.
Valuation multiples based on profitability
Standard accounting profitability indicators are well known to business people, professional advisors and government agencies. They are often used in formal business appraisals, especially those requiring regulatory filings with the government agencies such as the SEC. Here are top ones:
When valuing private companies use caution with EBITDA. If the business assets are depreciated aggressively, EBITDA will be too high and the value of business overstated. You may need to adjust the depreciation in line with the economic use of the business assets.
Cash flow based valuation multiples
Cash flow is the preferred basis for economic business value assessment. Not surprisingly, you will find a number of multiples that help you value a business based on its ability to generate cash flow. Here are some examples:
Valuation multiples based on business assets and equity
For asset rich firms in the manufacturing, distribution, and retail industry sectors business assets are usually important indicators of what the business is worth.
In addition, business people may want to know the difference between the book value and economic value of their ownership interests. Typical valuation multiples in this category are:
Business value to total assets.
Business value to fixed assets such as furniture, fixtures and equipment (FF&E).
Business value to owners’ equity.
Choosing your valuation multiples
You have a number of options when choosing the right valuation multiples in you business appraisal. As with any method, the choices are dictated by the purpose of your business valuation and the specific value factors present in the subject business. Here are some thoughts to ponder:
You may choose to focus on the revenue growth potential when valuing a young growing company. The business may be generating respectable sales but not be optimized for top profitability. Some well planned operational changes may well improve its cost structure resulting in higher profits down the road. Valuation multiples based on gross revenue or net sales are a good choice here.
Established businesses being valued for merger or acquisition often rely on the EBIT or EBITDA based valuation multiples. Again, these accounting measures are well known. In addition, they help you value the company regardless of the capital structure used – something that is likely to change anyway following the transaction.
If you are appraising a privately owned business, cash flow is the typical basis. The economic potential of owner-operator managed companies is best assessed using the firm’s discretionary earnings such as SDCF. For larger firms being acquired by a single buyer or private equity firm the net cash flow based multiples are an excellent choice.
Using a number of valuation multiples
You can significantly improve the accuracy of your market-based business valuation by using a number of different multiples at once. You can then apply an averaging scheme to the results you get, or establish a range of possible business values, from low to high.
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