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:
- Business enterprise value (EV) to gross profit.
- Enterprise value to net income.
- Enterprise value to EBITDA or EBIT.
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.