There are several valuation methods to determine what your business is worth. One of the most common methods is applying an appropriate “market multiple” to an appropriate “cashflow” of the business. This valuation approach is also known as the Price/EBITDA or the Price/SDE approach, while many refer to it as the “Market Multiple Approach”. It is a 2-part process where you calculate the cashflow of the business and then multiply it with your company’s “market multiple” to determine your business’ value.
Two of the predominantly used types of “cashflows” are EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and SDE (Seller’s Discretionary Earnings). EBITDA is used more for businesses that have cashflows greater than $500,000, while SDE is typically used for businesses with less than $500,000 in cashflow. However, these are loose “rules of thumb” and other factors need to be taken into consideration, including any required adjustments, when determining what type of cashflow to apply in your valuation model.
The market multiples portion of the valuation equation revolve around identifying what the appropriate market multiple is. To determine the appropriate market multiple, valuation professionals look at other businesses that have recently sold in the same industry, that are close to the same size, and that are in the same geographic region. There are several other factors that should be used to calculate the appropriate market multiple to be applied, which can leave room for error. However, conducting the appropriate research and discussing with professionals can assist in identifying what the appropriate market multiple would be for your specific business.
Another valuation approach to determine the value of your business is known as the “Price/Revenue” or “multiple of revenue” approach. This is another value-based valuation formula if you are thinning “ I want to sell my business,” that requires calculating figures, just like the aforementioned “Market Multiple” method above. The multiple of revenue valuation method takes the total annual revenue, then multiplies it by a data-backed percentage determined by the industry benchmark. This benchmark takes into consideration other external factors, such as the economy and current situations of the industry. However, financial experts have argued that the multiple of revenue approach may not be the most reliable valuation method due to its lack of consideration of other crucial factors, with a tendency to overfocus on revenue. By and large, a company’s valuation should be determined by revenue, profit, and market demand and speaking to a professional.