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 business with the time’s revenue method.
Business valuation based on revenue
For new and small company owners, business 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 of a business 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 business valuation should consider several other factors, a valuation based on revenue is ideal for getting a range for the selling price of the business. 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.
What are all the methods you can use to value your business?
Valuing a business can be done in a number of ways, but one common method involves deducting debts from assets. This straightforward approach, however, doesn’t always reveal all of a company’s worth. That’s why a lot of other approaches exist. In order to better understand a company’s financial health, we will examine several approaches to valuing businesses.
- Market capitalization – In Market Capitalization, Value is determined by the multiplication of the share price of the business by its outstanding shares.
- Earning multiplier – It modifies the P/E ratio to take current interest rates into account. The earnings multiplier compares projected profits with the cash flow that might be invested for the same time at the present rate of interest.
- Times revenue method – Here, a stream of revenues is multiplied by industry- and economy-specific factors.
- Discounted Cash Flow – This business valuation method is comparable to the earnings multiplier. It adjusts future cash flow predictions to determine the present market value of a firm.
- Book Value – To determine the book value, subtract the overall liabilities of a corporation from its total assets.
- Liquidation Value – It is the value of the net cash that a company would obtain presently if its obligations were settled and its possessions were liquidated.
- Valuation Based on Geographical Location – The value of the business differs based on the geographical location, which should be considered in addition to the business valuation method used.
How to value a business based on its revenue?
Valuation 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 businesses.
Understanding the Times Revenue Method
The times revenue method is the most popular business valuation method to determine the worth of a revenue-based business. 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 multiple could be twice or the same as the present revenues, depending on the sector and the regional business trends and economic situation. The multiple could even be lower than one in specific sectors.
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.
A small business receives the lowest value or the least price to sell the business for by liquidation value of all business assets. With the times revenue method, they determine the highest value. This gives the owners an idea of what value the business should be sold for. The values obtained by applying the revenue multiple can then serve as the starting point for a more complete formal valuation procedure.
How does it work?
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 business 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 times revenue method
The times revenue method is not an accurate method of business 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.
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!
Eqvista is here to help businesses function 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.