Determining the potential value of a business if it were to be sold is important for entrepreneurs and prospective buyers alike. The most common method used is applying an industry-specific multiple to the company’s earnings or revenue.
For established businesses that are profitable, multiples of net income are typically used. Take the net profit from the most recent 12 months of financial statements. Then look up the average valuation multiple for that particular industry – for example, technology companies often use higher multiples than construction firms. Multiply net income by this multiple to estimate a sale valuation range.
EBITDA is also commonly used instead of plain net income. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Take net profit and add back any interest, taxes, depreciation and amortization to get a true cash flow earnings number. Apply the standard multiple to EBITDA for valuation purposes.
For newer startups that may be losing money as they scale, revenue multiples can be used instead. Look up the industry average multiple of gross revenue. Take the total revenue generated over the past year and apply the standard multiple to estimate valuation.
The key is identifying the relevant industry multiples, whether based on earnings or revenue. Apply the appropriate multiple to the correct metric in order to determine a ballpark valuation range if you were looking to sell or acquire a business.
