Profit Based Business Valuation: How Many Times Profit is a Business Worth?

The financial value of your company – This one number is used for lots of different purposes. It might be used to attract investors. It could be used to protect your assets. It could even be used to sell your company one day. The reasoning behind this number is what makes it so important, but there are many methods of business valuation available today, and understanding which one is right for your company so that you get an accurate portrayal is absolutely essential. One method many stakeholders rely on is profit-based business valuation.

What It Is

The profit based business valuation method primarily relies on a close look at the net profit of the business. That net profit is then multiplied by an industry-standard multiple. How many times profit is a business worth? That depends on a number of factors.

Why It’s Useful

The profit based business valuation method is particularly useful because as long as the company continues to pull profits in at the same basic level, those in charge will see a complete return on their investment. Moreover, this type of valuation is incredibly helpful for service-based companies like those in healthcare.

How It’s Done

To use this method, you’ll need the annual net profit earned by the business each year and the industry multiplier. That industry multiplier is typically the harder number to get. You’ll need to do a bit of research to come up with the common number used in your industry. These numbers are often available from services like Capital IQ and Bloomberg. In the food service business, the number is two. Other industries use other numbers, and those are typically widely available with a bit of research. 

While the industry multiplier may seem like the more difficult number to get, profit is actually the harder number to come up with. After all, what exactly makes up profit? 

Any basic business class will tell you that profit is the total revenue minus the total expenses, but knowing what goes into those two numbers can be complex. Expenses should include both direct costs like wages as well as indirect costs like rent. They should also include things like interest expenses on business loans. Profit should be based on an average of at least the last three years to offer a better overall picture of the health of the business. 

The Drawbacks

While the profit based business valuation method can be quite helpful, it does have some drawbacks. First, it doesn’t work well for start-up companies. Most of these have yet to turn a profit, but that doesn’t make them worthless. More than that, though, is the fact that some companies don’t have a profit for many years. Biotech companies, for example, will have years of costs until their treatment method is FDA approved. Once it can become commercially available, it may begin to find a profit. Finally, companies can manipulate numbers using a variety of different accounting methods, which may affect overall profit numbers, so it’s tough to understand exactly what profit means to each company. 

Let AMB Help

If you’re interested in taking a closer look at a profit based business valuation, or just at the value of your company as a whole, or even if you just want to know how to truly increase the profitability of your company, then we can help. Contact us today to learn more.