AMB Performance Group Blog

Small Business Owners: How to Value a Small Business Based on Revenue

Posted on: July 22, 2022
Business Valuation

What a company is truly worth can be a bit subjective at times. After all, almost all businesses start with an idea that’s carefully nurtured and grown to become something much bigger and more powerful. Whether you’re looking to sell the company you’ve worked so hard to grow or buy someone else’s company, understanding what a company is worth is an absolute must. Hard figures are all that matter in this space. Any understanding of business valuation begins with the idea that there are four basic approaches to valuing a company. Each of them can often reveal something different about the company. One key option is the revenue-based approach, and understanding how to value a small business based on revenue can tell you a lot about what the company is truly worth

A Quick Dictionary

To better understand how to value a small business, you’ll first need to understand some well-accepted industry terms. 

  • EBITDA: This complex acronym stands for earnings before interest, tax, depreciation, and amortization. It’s a fairly common acronym, and while it requires a bit of data, it’s all information you should have on hand or be able to obtain fairly easily. 
  • EBIT: This is a version of the acronym above. It stands for earnings before interest and taxes. 
  • Net Profit After Tax: This is essentially a business’s bottom line, and it’s one of the numbers that will matter most in this calculation. 

A Straightforward Option

Wondering how to value a small business based on revenue? It’s a fairly easy method. Keep in mind, though, that it should be used carefully. It could deliver a fairly inflated valuation, which might overvalue a business, a serious problem if you’re looking to make a purchase. The reason for this is simple. They don’t take operating expenses into account, they just give you the pretty number at the end. As a result, you’re not getting an accurate picture of the cash flows this kind of business can provide. 

Making it Happen

So, how can you use this approach? You have two options. The first is discounted cash flow. Here, you’ll decide the present value of the company based on what you think the future cash flow of a company might be. That cash flow is typically discounted based on the risk involved with the company. 

The second option also calculates the profitability of a business based on future data, but it’s handled differently. It’s called the capitalization of earnings. Here, you consider the current cash flow, the annual rate of return, and the expected value of the company itself. This method can help you account for some changes in the future, but it also assumes that the calculations for a single point in time will continue throughout the lifecycle of the company. It can really only be used with companies that have stable profitability. 

Deciding Whether It’s Worth It

Still wondering how to value a small business based on revenue? Learning more about how to value a small business for sale is essential whether you’re ready to buy a new company or sell the one you’ve spent so much time building. At AMB, we’re focused on optimizing performance anywhere in the business lifecycle, and we can’t wait to help you get started. Contact us today to learn more about what we can do to help your company.

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