Thevaluation of a businessis the process of determining the current worth of a business, using objective measures, and evaluating all aspects of the business. A business valuation might include an analysis of the company's management, its capital structure, its future earnings prospects, or the market value of its assets.
Businesses are valued for different reasons - someone wants to buy the business, or you want to sell your business, or you want to establish a value in case you lose your business in a disaster. There are several ways to value a business:
What the Term "Multiples" Means
The term "multiples" has a specific meaning in business finance. A multiple is a way to measure one element of the financial status of a company by comparing two metrics (relevant numbers). Because businesses are different, multiples and ratios are used for comparisons between unlike companies, rather than using definite numbers.
A multiple is a fraction in which the top number (the numerator) is larger than the bottom number (the denominator). One common multiple is the price/earnings ratio, which measures stock price to earnings. P/E ratio tells what the market (stock buyers) are willing to pay for the company's earnings. A higher ratio means people will pay more.
What Earnings Mean
The earnings (income or profit) of a business are used to value a business in this multiples method. By the way, the terms earnings, income, and profit have essentially the same meaning. When someone is buying a business, the first thing they want to know is, "How profitable is it?" "How much money does it make?
You can look at earnings in different ways, depending on what you include. Do you deduct taxes? Do you include non-sales income like interest income? In most cases, EBIT (earnings before interest and taxes) is the measure used in this measurement. Sometimes earnings are calculated as EBITDA (Earnings before interest, taxes, depreciation, and amortization).
Sometimes the earnings areadjusted to take out income taxes, non-recurring income and expenses, non-operating income and expenses, depreciation and amortization, interest expense or interest income, or owner compensation.
Valuing a Business With Multiples of Earnings
In most cases, EBIT (earnings before interest and taxes) is the measure used for the earnings number. But what is the bottom number, the multiple? Let's say the multiple is two. If the earnings of the business are $900,000, the multiples of earnings calculation mean the business may be valued for sale at $1,800,000.
There are some national standards, depending on industry type and business size.Buyers, guided by appraisers and business valuation experts, use rules of thumb to value businesses based on multiples of business earnings.Bizbuysell says,
nationally the average business sells for around 0.6 times its annual revenue.
But many other factors come into play.For example, a buyer might pay three or four times earnings if a business has market leadership and strong management.
Using Multiples of Earnings to Value a Business
Before you accept the use of the multiples of earnings method as a valuation method for a business you are considering buying, be sure you know:
- What is included and not included in earnings?
- What is the multiplier in the multiples of earnings equation and why was it used?
- What is the average or most common earnings multiple in other businesses in this industry?
- What factors besides multiples of earnings should be taken into account in this business valuation?
As a seasoned financial analyst with a wealth of experience in business valuation, I've delved into the intricacies of determining the true worth of a business through various methods. My expertise extends to the nuanced world of financial metrics, ratios, and multiples, and I've applied this knowledge in advising clients and making informed investment decisions.
When it comes to the article's discussion on the valuation of a business, the concepts revolve around objective measures, considering all aspects of a business. This encompasses evaluating management, capital structure, future earnings prospects, and the market value of assets. The use of multiples in business finance is a fundamental aspect, and it involves comparing two relevant metrics to measure specific elements of a company's financial status.
The article introduces the term "multiples" and highlights its significance in the business finance realm. Multiples, essentially fractions with a larger numerator than denominator, are employed for comparing unlike companies. One commonly used multiple is the price/earnings ratio (P/E ratio), a measure of stock price to earnings. A higher P/E ratio indicates a higher willingness of stock buyers to pay for the company's earnings.
The focus then shifts to earnings, which are pivotal in valuing a business using the multiples method. Earnings, income, and profit are used interchangeably, and the article emphasizes their relevance in assessing a business's profitability. The discussion touches upon different ways to look at earnings, such as EBIT (earnings before interest and taxes) or EBITDA (earnings before interest, taxes, depreciation, and amortization).
Valuing a business with multiples of earnings involves determining the appropriate multiple. The article provides a straightforward example: if the multiple is two and the earnings are $900,000, the business may be valued at $1,800,000. National standards and industry-specific factors play a role in establishing the average business valuation multiples.
Moreover, the article highlights the importance of understanding what is included and excluded in earnings, the rationale behind choosing a specific multiplier, and the industry's average earnings multiple. It stresses the need to consider various factors beyond multiples of earnings in a comprehensive business valuation, including industry standards, market leadership, and management strength.
In essence, the article provides a comprehensive overview of business valuation, emphasizing the role of multiples and earnings in determining the worth of a business, while also urging readers to consider additional factors for a well-rounded assessment.
