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:
|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.