What is Revenue Multiple?
A Revenue Multiple measures the valuation of an asset, such as a company, relative to the amount of revenue it generates. While revenue-based multiples are seldom used in practice and are perceived as a last resort, unprofitable companies often have no other option.
How to Calculate Revenue Multiple (Step-by-Step)
A revenue multiple is a form of relative valuation, where an asset’s worth is estimated by comparing it to the market’s pricing of comparable assets.
Usually, multiples with revenue as the denominator are most often used to value companies with negative profit margins that cannot be valued by other traditional valuation multiples (e.g. EV/EBITDA, EV/EBIT).
In general, a revenue-based valuation multiples is rarely used unless there are no other options available (i.e. if the company is unprofitable).
The two most common variations are the following:
Learn More → Valuation Multiple
Revenue Multiple Formula
Starting off, the EV/Revenue is the ratio between a company’s enterprise value and revenue.
EV/Revenue = Enterprise Value ÷ Revenue
Next, the price-to-sales ratio is the ratio between a company’s market capitalization (“market cap”) and sales.
Price-to-Sales (P/S) = Market Capitalization ÷ Sales
The distinction between the two multiples is related to the necessity for the numerator and denominator to match in terms of the group of stakeholders represented.
- EV/Revenue → Enterprise Value Multiple
- Price-to-Sales → Equity Value Multiple
The EV/Revenue calculates the value of the firm’s operations to all stakeholders, such as debt and equity investors. In other words, the calculated valuation is the company’s enterprise value, which represents the total firm value, i.e. the value of a company from the perspective of all of its stakeholders, such as its common equity shareholders, preferred stockholders, and debt lenders.
The price-to-sales ratio, in contrast, calculates the equity value, otherwise known as a company’s market capitalization. Unlike the enterprise value, the market cap is the residual value of a company from the viewpoint of solely common shareholders.
Revenue Multiples: Pros and Cons
In comparison to earnings multiples, such as EV/EBITDA, revenue-based multiples are less prone to discretionary accounting decisions by management that can skew results.
While earnings multiples are used far more frequently in practice, one major drawback is that decisions such as the useful life assumption on depreciation, inventory recognition policies, and research and development (R&D) spending can all influence the resulting implied valuation.
Revenue multiples can be used for companies that are either unprofitable or have limited profitability, which is their primary use case.
The lack of profitability could be the result of the company being in the early stages of its lifecycle (i.e. startups), or the company may currently be struggling to turn a profit.
On the other hand, revenue-based multiples neglect profitability, which arguably is the most important factor that determines the long-term sustainability of a company.
All companies, at some point, must become profitable for their free cash flows (FCFs) to fund their day-to-day operations and spending requirements. Often, revenue-based multiples can attach a premium to high-growth companies without consideration of their profit margins and cost management.
SaaS Valuation Multiples and Unprofitable Startups
For early-stage companies exhibiting high growth, an earnings multiple is not feasible if the company is not yet profitable.
Oftentimes, the companies valued using revenue-based multiples are startups or late-stage growth companies in very competitive markets that recently became publicly traded.
In the latter case, the competition in the market causes companies to prioritize growth and increased scale over profitability.
While not optimal, a company’s negative earnings limit the ability to use traditional valuation multiples, forcing reliance on other options.
Revenue Multiple Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Revenue Multiple Calculation Example
Suppose a company’s shares are currently priced at $10.00 each, with 5 million shares in circulation on a diluted basis.
- Current Share Price = $10.00
- Diluted Shares Outstanding = 5 million
Given those two assumptions, the company’s market capitalization is $50 million.
- Market Capitalization = $10.00 × 5 million = $50 million
We’ll also assume the company’s net debt balance (i.e. total debt less cash) is $10 million and its revenue for the fiscal year 2021 is $20 million.
- Net Debt = $10 million
- Revenue = $20 million
The fact that the company’s net debt is half of its total revenue suggests operations are funded via external financing, i.e. debt, rather than its own cash flows.
After adding the company’s net debt to its market capitalization, i.e. equity value, the enterprise value (TEV) comes out to be $60 million.
- Enterprise Value (TEV) = $50 million + $10 million = $60 million
We calculate the EV/Revenue and price-to-sales ratios as the following:
- EV/Revenue = $60 million ÷ $20 million = 3.0x
- Price-to-Sales = $50 million ÷ $20 million = 2.5x
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Sure, I can delve into the details of the concepts mentioned in the article on Revenue Multiples. The Revenue Multiple is a key valuation metric used in finance to determine the worth of an asset, typically a company, concerning the revenue it generates. This metric is especially crucial when valuing companies that are unprofitable or have negative profit margins, which makes them challenging to value using traditional metrics like EV/EBITDA or EV/EBIT.
Two common Revenue Multiples are Enterprise Value-to-Revenue (EV/Revenue) and Price-to-Sales Ratio (P/S). The EV/Revenue ratio is calculated by dividing the enterprise value of a company by its revenue. On the other hand, the Price-to-Sales ratio is obtained by dividing the market capitalization of the company by its sales revenue.
The distinction between these two multiples lies in what they represent. EV/Revenue pertains to the enterprise value, considering the total firm value from the perspective of all stakeholders, including equity and debt investors. Conversely, the Price-to-Sales ratio focuses on equity value or market capitalization, representing the residual value of the company from the standpoint of common shareholders.
Utilizing Revenue Multiples has its advantages and drawbacks. Unlike earnings-based multiples like EV/EBITDA, Revenue Multiples are less susceptible to accounting decisions that might skew results. However, they disregard profitability, a crucial factor for a company's long-term sustainability. While they can be instrumental for unprofitable or early-stage companies experiencing high growth, they might not adequately reflect the profitability necessary for long-term success.
For instance, in the case of startups or companies in competitive markets aiming for growth over profitability, Revenue Multiples become more relevant. Yet, solely relying on these metrics can overlook the importance of eventual profitability for sustained operations and cash flow management.
The article even provides a hands-on example of calculating these multiples using specific financial data, like market capitalization, revenue, and net debt. Such calculations showcase how these ratios, EV/Revenue and Price-to-Sales, are derived and used to assess a company's valuation based on its financials.
This comprehensive guide touches upon various facets crucial in understanding and applying Revenue Multiples in financial valuation, encompassing concepts like enterprise value, market capitalization, revenue, and their interrelationships in determining a company's worth.
