How to Calculate the Value of a Business Based on Revenue?
Business valuation can be done in a variety of ways, each of which produces a distinct outcome. Different types of business valuation methods have different implications for businesses and affect their mergers and acquisition (M&A) goals. This is why it is crucial that a business owner chooses the right technique of valuation. One way to find the worth of a business is through its revenue. Valuation based on revenue is influenced by a variety of variables, such as industry, market trends, and the state of the economy. Young private enterprises with small or negligent profits or very erratic profit rates should use this strategy. This article will discuss how to value a revenue-based with the time’s revenue method.
Business valuation based on revenue
For new and small company owners, valuation based on revenue is appropriate among several business valuation methods. Additionally, businesses that are expected to see rapid development, such as providers of software-related services, often depend on a valuation based on revenue.
Understand business valuation
Business valuation is determining a firm’s economic worth. It is also referred to as a company valuation. The fair worth can be established via a business valuation for a number of purposes, such as for M&A, determining partner ownership, taxes, and even during divorce processes. All aspects of a company are examined to assess its value and the value of its assets throughout the valuation process. For an unbiased assessment of the worth of the company, owners typically resort to qualified experts in business valuation.
Why do you need to value a business based on its revenue?
Valuing a business based on its revenue is the easiest technique to get a good estimation of your company’s worth. While a proper valuation should consider several other factors, a valuation based on revenue is ideal for getting a range for the selling price. It is exceptionally ideal for early enterprises that show volatile profit rates or near-zero profit rates. In this case, profits don’t play a huge role in business valuation, and a valuation based on revenue proves to be more accurate.
How to value a business based on its revenue?
To value a business based on revenue does not just depend on the revenue of the business, but several other factors as well. Let us look at the Times Revenue Method, the most important method to determine the worth of revenue-based.
Understanding the Times Revenue Method
A business’s present worth can be estimated using the times-revenue technique of valuation based on its expected future profits. By allocating a revenue multiple to the company’s present revenue, the future profitability range is determined.
The times-revenue approach results in a spectrum of values for a firm. A multiplier establishes a range to base the owner’s estimation when negotiating the amount of the sale of the business. This amount is based on real revenues for a specific period.
Here is how to calculate the value of a business based on the times revenue method:
- Determine the company’s annual revenue: This is typically calculated as an average of the past 1-3 years of revenue to smooth out any fluctuations.
- Select an appropriate revenue multiple: This multiple varies across industries and depends on factors like growth potential, profit margins, and risk profile of the business. Some typical revenue multiples:
- Software/tech companies: 1.5x – 4x revenue
- Service businesses: 0.5x – 1x revenue
- Retail/restaurants: 0.25x – 0.75x revenue
- Adjust the revenue multiple if needed to account for the specific company’s strengths/weaknesses compared to industry peers (e.g. higher growth, better margins etc.).
- Calculate the company’s value by multiplying the annual revenue by the adjusted revenue multiple: Business Value = Annual Revenue x Adjusted Revenue Multiple
For example, a software company is seeking for a valuation, here are some basic statistics: Annual revenue = $6 Million
An appropriate multiple for its industry and growth rate is 3.5x, In this case, its estimated value would be: Business Value = $6 million x 3.5 = $21 million.
The times revenue method provides a maximum valuation estimate. It does not account for profitability, so the intrinsic value of a highly profitable company may be higher than this estimate. It is best used for young companies with little/no profits, or those with high growth potential where future revenues are more valuable than current earnings. For mature, profitable businesses, methods based on cash flows or earnings are generally preferred.
KEY FACTORS TO CONSIDER FOR TIMES REVENUE METHOD
When valuing a business based on its revenue using the times revenue method, there are several key factors to consider,
| Industry and business type | The suitable revenue multiple can change and it depends upon the types of business and industries. |
| Growth prospects | Companies with strong growth prospects in revenue and earnings tend to have higher revenue multiples compared to those with stagnant or declining growth. |
| Profit margins | While the times revenue method doesn't directly account for profits, the multiple implicitly factors in the typical profit margins for that industry. |
| Risk profile | Riskier businesses with volatile revenues, customer concentrations, or high operating leverage tend to have lower multiples compared to stable industry with recurring revenue streams. |
| Comparable company data | Analyzing the revenue multiples of similar public companies or recent acquisitions in the same industry provides guidance on an appropriate multiple range. |
| Recurring vs. non-recurring revenue | Businesses with a high proportion of recurring, subscription-based revenue are often valued at a premium compared to those with one-off, project-based revenues. |
| Economic conditions | Multiples tend to be higher during economic expansions and lower during recessions, reflecting changes in risk perception and growth expectations. |
HOW TIMES REVENUE METHOD VALUE BUSINESS BASED ON REVENUE?
The multiplier’s value depends on the time frame for which the income is taken into account or the technique used to quantify the revenue. The multiplier might be further influenced by aspects of the particular company.
For instance, the times revenue multiplier assigned to a slowly expanding company with limited potential, low projected revenue, and a low proportion of repeating revenue can be less than one. Similarly, a company with more projected growth and greater repeating revenues will have a high multiplier. The revenue multiple is the most important factor in figuring out the value.
The times-revenue is computed by dividing a company’s selling price by its revenue over the previous 12 months. The outcome shows how much a buyer was willing to pay for a firm, expressed as a multiple of yearly revenue.
Alternatively, multiply the annual revenue by the desired times-revenue objective to determine a possible target price. The gross yearly revenues and sales value of a selection of similar companies within the online industry payday loan is used to calculate revenue multiples.
How can it be useful in valuing the revenue-based business?
To get a reference point for the acquisition price for a business, times-revenue is a great valuation method. A buyer can determine a suitable selling price by attributing the time’s revenue they are willing to pay. Additionally, the seller can also set his or her expectations and then can assess the same value with the times revenue method to see if the value they he/she is paying is appropriate or not.
CHALLENGES OF VALUING A BUSINESS BASED TIMES REVENUE METHOD
The times revenue method is not an accurate method of valuation but rather a point to initiate a thorough valuation process. The expenditures a firm incurs or the profits of a corporation are not taken into account by the times-revenue technique.
Let’s take an example. When compared to the previous year, a business’s revenue could well have increased by 20%, but its costs also increased by 30%. However, in times revenue method, a rise in sales does not always mean a rise in profits. An organization’s value should take into account more than just its income stream for a complete valuation.
The times revenue method of valuing a business has several key challenges:
- Revenue does not equal profit. This method fails to account for the costs and expenses involved in generating revenue, so an increase in revenue does not necessarily translate to an increase in profits.
- It does not consider the company’s growth patterns, margins, or recurring revenue streams, which are important value indicators. Relying solely on a revenue multiple oversimplifies the valuation.
- The appropriate revenue multiple can vary significantly across industries and individual companies based on growth potential, risk profile, and profit margins. Selecting the right multiple is challenging.
- For companies with volatile or unpredictable revenue streams, using a single revenue figure may not accurately reflect the true value potential.
- This method is most suitable for young companies with little to no earnings or high growth potential. Valuations based on earnings or cash flows are generally preferred for established, profitable businesses.
In summary, while simple to calculate, the times revenue method has limitations in accurately capturing a company’s intrinsic value, as it fails to account for profitability, growth prospects, and other key value drivers.
Additionally, margin, growth trends, and recurring revenue are important determinants of a company’s worth. The times revenue method is just to get owners started estimating the business’s selling price. It is essential to use more than one approach, not simply one formula.
Other multiples you can use to value revenue-based business
The worth of a firm is assessed using the multiples approach, which compares it to other companies of a similar kind that use more financial measures. This method is comparable to the valuation of property by considering recent sales of nearby, comparable properties. Let’s look at some more multiples for business valuation–
- EBITDA – It stands for Earnings before interest, tax, depreciation, and Amortisation and is the most often used valuation metric that substitutes the business’s free cash flow. It often ranges from 6x to 18x.
- EBIT – It stands for Earnings before interest and taxes. EBIT accounts for amortization and depreciation when non-cash charges represent expenses related to utilizing assets that ultimately need replacement. Frequently, it varies between 10x and 25x.
- Net profit after tax – The bottom line is the general reference for Net profit after tax. It is computed by taking the revenues the company has generated and deducting all costs and income taxes.
When should you consider using these multiples to value a business?
Early-stage enterprises are best valued using a revenue multiple, particularly if they are breaking even or making negligible profits. A good valuation can be accomplished as long as the revenue multiple employed is real, accurate, and comparable in the industry. In order to accelerate revenue growth, a number of these initial enterprises reinvest their sales revenues back into the company growth. These multiples are helpful for evaluating consumer-based firms or companies in the technology industry that generate substantial recurring income through subscription-based products.
Get your business valuation from the industry’s leading experts with Eqvista!
While simple and useful in some cases, the times revenue method should be used cautiously, often as a preliminary valuation tool or sanity check, and in conjunction with other more rigorous techniques for a comprehensive assessment.
Eqvista is here to help more efficiently with a group of accountants, lawyers, valuation experts, and company owners. Getting a business valuation is a crucial part of growing your company. Our highly skilled valuation experts at Eqvista can assist you in determining the worth of your company, be it in the pre-revenue phase or requires thorough corporate valuation. From the creation of your business to the management of shares, Eqvista’s business valuation covers it all. To learn more about our valuation services, get in touch with us.
