Revenue/earnings multiple
A more common – and simpler – method of valuing small- and medium-sized businesses uses a multiple of revenue or earnings/EBITDA. This calculation involves taking a company's earnings after all business expenses are paid and using a current industry multiplier to generate a value.
Take your total assets and subtract your total liabilities. This approach makes it easy to trace to the valuation because it's coming directly from your accounting/record keeping.
To find the fair market value, it is then necessary to divide that figure by the capitalization rate. Therefore, the income approach would reveal the following calculations. Projected sales are $500,000, and the capitalization rate is 25%, so the fair market value is $125,000.
A good revenue multiplier typically ranges from 1 to 3 times annual revenue for most small businesses. However, this can vary significantly based on industry, market conditions, and specific business characteristics.
The revenue multiple is the key factor in determining a company's value. To calculate the times-revenue, divide the selling price by the company's revenue from the past 12 months. This ratio reveals how much a buyer was willing to pay for the business, expressed as a multiple of annual revenue.
A service-based business with $1 million in sales was valued at 2x revenue due to its reliance on human capital and limited scalability. Despite strong profitability, the business's valuation was $2 million, highlighting the importance of industry-specific factors in determining value.
In short, this method is all about calculating the multiples of net income. To calculate multiple net income, multiply your net operating income (NOI) by the net income multiplier (NIM) to calculate multiple net income. You'll arrive at your business's market value at which you'll sell. = NIM X NOI.
So as an example, a company doing $2 million in real revenue (I'll explain below) should target a profit of 10 percent of that $2 million, owner's pay of 10 percent, taxes of 15 percent and operating expenses of 65 percent. Take a couple of seconds to study the chart.
Common Multiples
Service businesses: 1.5 to 3.0 (i.e., cash flow x 1.5-3.0 multiple) Food businesses: 1.5 to 3.0 (i.e., cash flow x 1.5-3.0 multiple) Manufacturing businesses: 3.0 to 5.0+ (i.e., cash flow x 3.0-5.0+ multiple) Wholesale businesses: 2.0 to 4.0 (i.e., cash flow x 2.0-4.0 multiple)
Asset-Based Valuation is a method used in company valuations to determine a company's worth based on its tangible assets. This approach calculates the company's value by summing up the value of its assets and subtracting its liabilities. Tangible assets may include property, equipment, inventory, and investments.
Let's look at an example. You already know that when the entrepreneurs ask for their desired investment, they've placed a value on their company. For example, asking $100,000 for a 10% stake in the company implies a $1 million valuation ($100k/10% = $1M).
Valuation specialists commonly assess a small business based on their price-to-earnings ratio (P/E), or multiples of profit. The P/E ratio is best suited to companies with an established track record of annual earnings.
The Net Book Value (NBV) of your business is calculated by deducting the costs of your business liabilities, including debt and outstanding credit, from the total value of your tangible and intangible assets.
Current Value = (Asset Value) / (1 – Debt Ratio)
To quickly value a business, find its total liabilities and subtract them from the total assets. This will give you an idea of its book value. This formula estimates the worth of a business by looking at its assets and subtracting any liabilities.
What's a good profit margin for a small business? Although profit margin varies by industry, 7 to 10% is a healthy profit margin for most small businesses. Some companies, like retail and food, can be financially stable with lower profit margin because they have naturally high overhead.
Most small businesses generally sell at 2-3 times their seller's discretionary earnings.
Calculate Selling Price Per Unit
Identify the total cost of all units being bought. Divide the total cost by the number of units bought to obtain the cost price. Use the selling price formula to find out the final price i.e.: SP = CP + Profit Margin.
If the target store has annual revenue of $2 million, its estimated value would be $3 million.
The fair market value of a business can be determined by subtracting total assets from total liabilities and then factoring in future cash flows at a discounted rate.
Car Dealerships – dealers often cite 'Blue-Sky' multiples, being the amount of goodwill value of the dealership. 'Blue-Sky' value is calculated as pre-tax income multiplied by the 'Blue-Sky' multiple which is typically derived from industry publications and informed by precedent transactions.
When valuing a business, you can use this equation: Value = Earnings after tax × P/E ratio. Once you've decided on the appropriate P/E ratio to use, you multiply the business's most recent profits after tax by this figure.
It's actually pretty straightforward how to calculate a company's net worth: Total assets minus total liabilities = net worth. This is also known as "shareholders' equity" and is the same formula one would use to calculate one's own net worth.