How to Value a Business Based on Revenue
Valuation of a Private Company
Complex math might not be on your day-to-day agenda as you work to improve your company, but if you’re considering a business valuation, it certainly should be. If you are wondering how to value a business based on revenue, then read this first, and then contact us.
A business valuation gives you a closer look at exactly what your business is worth, and it can be helpful in a number of situations. For example, if you’re working to insure your company, you’ll need some solid numbers to get the quotes you want. If you’re doing some retirement planning or you intend to bring a new partner aboard in the near future, some business valuation is necessary too. No matter why you want to do a business valuation, understanding how to do a small business valuation is absolutely key as you work to move forward.
Three Very Different Methods for Valuation of a Business
There are three different ways to complete a small business valuation. The first, the assets-based approach, is primarily focused on the fair market value of a company. It looks at all of the assets put into a business to come up with an overall value. With this method, you essentially take the net asset value, subtract the total liabilities, then come up with an overall value for the company. The problem with this method, though, is that the actual value of the company is probably quite a bit higher than the assets. For example, imagine your company came up with a really unique product no one else is marketing. That knowledge can’t get recorded on your company’s assets sheet. Instead, all that can go on there is what you have in the bank and what you currently own.
The second method is almost as simple, but it, too, can be fairly problematic. It’s the market value approach, and the goal here is to compare your company with other companies that have recently been sold in your industry. This method can be helpful because it shows the value of an intangible asset, but the problem here is that if there are not similarly sized companies within your industry, it can be tough to find those comparisons.
The third method is likely the most well-rounded. It’s the revenue-based approach. While it’s the most complex of the three, it really offers a solid picture of a business should an owner be ready to sell. The goal here is to determine the company’s future economic benefits. But to do so, numbers have to be carefully adjusted for forecasted growth rates, overall cost structures, potential taxes, and more, and all of that has to be discounted to a present value.
How to Value a Business Based on Revenue
The method begins when you take your current income (or what you’ve earned) and use a multiplier that fits your industry to come up with the best value. For example, if the industry standard multiple is three times sales, and you did $60,000 in business last year, your business’ value would be $180,000.
The method sounds simple, but there are a few different ways to handle it, and some are far more complex than others. The most common way to do this is to capitalize on your past earnings. You calculate the net present value of the expected future cash flow for your company. To make it happen, you’ll need to find out the capitalization rate for your industry and business. Typically that is 20 – 25 percent, but that’s not always true, so you’ll have to do the research to make it happen. Another version involves examining what you’re making now, then making a number of projections about future earnings, then using the right multiple to come up with a potential valuation.
Are There Drawbacks to this Method?
This method of business valuation isn’t right for every company. It could give you a fairly inaccurate figure if the research isn’t done well. More than that, though, because it can’t take into account potential market changes and factors, you may not get a clear picture. It also isn’t the best predictor for companies that are just getting started, as the numbers just aren’t there to predict future market earnings.
Let Us Help
At AMB, we work with owners on a regular basis who are wondering how to value a business based on revenue. We can help you truly determine the metrics of your company. Our free business health check is a step in the right direction as you work to develop and define your company’s upcoming goals. Ready to decide how well your company is doing and what it’s truly worth? Reach out to us today to learn how we can help you decide exactly how to value your business and how to move forward.