Want to know your business value based on turnover? You’re not alone. Many entrepreneurs and investors use turnover multiples to quickly estimate a company’s value. It’s a simple yet effective method that suits businesses with stable sales and profit margins.
In this guide, I’ll break down 9 proven formulas and real-world examples to help you master business valuation by turnover. You’ll learn:
- What turnover multiples are and how they work
- The benefits of valuing a business based on sales
- Step-by-step calculations and key factors that affect valuation
- Average turnover multiples by industry
- Other valuation methods to consider
By the end, you’ll have a clear understanding of how to value a business based on its revenue. Let’s dive in.
What is Business Valuation by Turnover?
- Business valuation by turnover estimates a company’s worth based on its annual revenue
- It uses multiples of the turnover to calculate the enterprise value
- This method is useful for businesses with stable sales and profit margins
Business valuation by turnover is a method of estimating a company’s worth based on its annual revenue or sales. This approach uses multiples of the turnover to calculate the enterprise value of the business. The turnover multiple varies depending on factors such as the industry, growth potential, and profitability of the company.
This valuation method is particularly useful for businesses with stable sales and profit margins. It provides a quick and straightforward way to estimate the value of a company without the need for extensive financial analysis or projections. However, it’s important to note that this method does not take into account other factors such as assets, liabilities, or future growth potential, which can significantly impact the overall value of a business.
Example of Business Valuation by Turnover
Let’s say a company has an annual turnover of $5 million and is valued at a multiple of 1.5 times its turnover. In this case, the estimated value of the business would be $7.5 million (1.5 x $5 million).
It’s essential to understand that different industries have typical turnover multiples that are used as benchmarks. For example, a software company with high growth potential might have a higher multiple compared to a mature manufacturing business with stable revenues. These industry-specific multiples are derived from market data and past transactions of similar businesses.
Types of Business Valuation Methods Based on Turnover
There are several types of business valuation methods that use turnover as a basis for calculating the enterprise value. Two common approaches are the revenue multiple valuation and the seller’s discretionary earnings (SDE) multiple.
Revenue Multiple Valuation
The revenue multiple valuation method values the business as a multiple of its annual revenue. This approach is straightforward and easy to understand, making it a popular choice for quick estimations. The multiple used in this method varies depending on factors such as the industry, growth rate, and profitability of the company.
For example, a company with an annual revenue of $10 million in an industry with an average revenue multiple of 2x would be valued at approximately $20 million (2 x $10 million). However, it’s crucial to note that this method does not account for the company’s expenses or profitability, which can significantly impact its overall value.
Seller’s Discretionary Earnings (SDE) Multiple
The seller’s discretionary earnings (SDE) multiple method calculates the value of a business as a multiple of its SDE. SDE is essentially the company’s revenue minus the cost of goods sold and operating expenses, before accounting for the owner’s compensation and discretionary expenses.
This method considers the owner’s total compensation and discretionary expenses, which can provide a more accurate picture of the business’s profitability. The SDE multiple used in this valuation approach varies based on factors such as the industry, growth potential, and risk profile of the company.
For instance, if a business has an annual SDE of $500,000 and is valued at a multiple of 3x, the estimated value would be $1.5 million (3 x $500,000). This method is particularly useful for small to medium-sized businesses where the owner’s compensation and discretionary expenses can have a significant impact on the company’s profitability.
References:
- Investopedia. (n.d.). Valuing a Company: Business Valuation Defined With 6 Methods. Retrieved from https://www.investopedia.com/terms/b/business-valuation.asp
Benefits of Valuing a Business Based on Sales
- Sales-based valuation provides a quick and simple way to estimate a business’s value
- Revenue reflects current market demand and the business’s ability to generate sales
- Suits businesses with intangible assets, such as service businesses
Simplicity and speed
One of the main advantages of using sales to value a business is its simplicity. Unlike more complex valuation methods, such as the discounted cash flow (DCF) approach, which requires detailed financial projections and assumptions, a sales-based valuation only requires the annual turnover figure. This allows for quick, back-of-the-napkin estimates that can be useful for initial assessments or rough comparisons.
Furthermore, the simplicity of this method makes it accessible to a wider range of people, including business owners, investors, and advisors who may not have extensive financial modeling expertise. This can facilitate faster decision-making and negotiations, as parties can quickly arrive at a ballpark figure for the business’s value.
Limitations of simplicity
However, it’s essential to recognize that the simplicity of a sales-based valuation comes with some limitations. By relying solely on revenue, this method does not account for other crucial factors that impact a business’s value, such as profitability, growth potential, and risk. Therefore, while a sales-based valuation can serve as a useful starting point, it should be complemented with other valuation methods and a thorough due diligence process to arrive at a more accurate and comprehensive assessment of a business’s worth.
Reflects current market demand
Another benefit of valuing a business based on sales is that it reflects the current market demand for the company’s products or services. Revenue is a direct indicator of a business’s ability to generate sales and attract customers. Generally, higher revenue suggests that the business is successfully meeting market needs and has a strong customer base, which translates into a higher value.
This is particularly relevant for businesses operating in dynamic or rapidly evolving industries, where historical financial performance may be less indicative of future potential. By focusing on current sales, a revenue-based valuation captures the business’s most recent performance and market positioning, providing a more up-to-date assessment of its value.
Importance of revenue growth
When evaluating a business’s revenue for valuation purposes, it’s crucial to consider not only the absolute revenue figure but also the growth trend. A business with consistently growing revenue is likely to be more valuable than one with stagnant or declining sales, even if their current revenue figures are similar. This is because revenue growth suggests that the business is gaining market share, expanding its customer base, or successfully introducing new products or services, all of which contribute to its future potential and value.
To assess revenue growth, investors and analysts often look at the compound annual growth rate (CAGR) over a specific period, typically three to five years. A higher CAGR indicates a faster pace of growth and can justify a higher valuation multiple. However, it’s essential to investigate the drivers behind the revenue growth to ensure that it is sustainable and not the result of one-time events or unsustainable practices.
Suits businesses with intangible assets
Sales-based valuation is particularly well-suited for businesses with significant intangible assets, such as service businesses, consulting firms, or technology companies. These businesses often lack substantial tangible assets, such as real estate or equipment, which can make other valuation methods, like the asset-based approach, less relevant.
In these cases, revenue is a better indicator of the business’s value, as it reflects the company’s ability to monetize its intangible assets, such as intellectual property, brand reputation, or customer relationships. By focusing on sales, a revenue-based valuation captures the value created by these intangible assets, which are often the key drivers of success for service-oriented businesses.
Importance of recurring revenue
For businesses with intangible assets, the quality and stability of revenue are often just as important as the absolute revenue figure. Recurring revenue, such as subscription-based services or long-term contracts, is particularly valuable, as it provides a predictable and stable income stream. This can lead to higher valuation multiples compared to businesses with more transactional or project-based revenue.
When evaluating a business with significant intangible assets, investors and analysts often assess the proportion of recurring revenue and the average customer lifetime value (LTV). A higher percentage of recurring revenue and a longer customer LTV can justify a higher valuation, as they suggest a more stable and predictable future performance.
Ease of benchmarking
Sales-based valuation also enables easier benchmarking against similar businesses, as revenue figures are more readily available and comparable than other financial metrics. This is particularly useful when valuing businesses in industries with a large number of comparable companies, such as retail, hospitality, or professional services.
By comparing a business’s revenue and valuation multiple to those of its peers, investors and analysts can gauge whether the valuation is in line with industry norms and identify potential over- or undervaluation. This benchmarking process can also help identify key factors that drive valuation differences within an industry, such as revenue growth, profitability, or market share.
Importance of choosing the right benchmarks
When using sales-based valuation for benchmarking purposes, it’s essential to choose the right peer group to ensure a fair and accurate comparison. Key factors to consider when selecting benchmarks include industry focus, business model, size, growth stage, and geographic footprint. Choosing benchmarks that are too dissimilar can lead to misleading conclusions and inaccurate valuations.
It’s also important to note that valuation multiples can vary significantly across industries, so it’s crucial to use industry-specific benchmarks when available. For example, the average revenue multiple for a software company may be significantly higher than that of a retail business, reflecting differences in growth potential, profitability, and risk profile.
Suitability for small and medium-sized businesses
Sales-based valuation is often more suitable for small and medium-sized businesses (SMBs) compared to larger, publicly-traded companies. This is because SMBs often have simpler financial structures and fewer complex assets, making revenue a more meaningful indicator of their value.
Moreover, SMBs may lack the detailed financial data required for more sophisticated valuation methods, such as the discounted cash flow (DCF) approach. In these cases, a sales-based valuation can provide a reasonable estimate of the business’s worth without requiring extensive financial modeling or forecasting.
Limitations for larger businesses
However, it’s important to recognize that sales-based valuation may be less suitable for larger, more complex businesses. As companies grow and mature, factors such as profitability, cash flow, and capital structure become increasingly important drivers of value. In these cases, a more comprehensive valuation approach that considers multiple financial metrics and business-specific factors may be necessary.
Furthermore, larger businesses often have more diversified revenue streams and business units, which can make a single revenue multiple less meaningful. In these cases, a sum-of-the-parts valuation, which values each business unit separately based on its specific characteristics and performance, may be more appropriate.
Conclusion
In conclusion, valuing a business based on sales offers several benefits, including simplicity, speed, and relevance to current market demand. It is particularly well-suited for businesses with intangible assets and SMBs, where revenue is a more meaningful indicator of value. However, it is essential to recognize the limitations of this approach and consider other valuation methods and factors to arrive at a comprehensive and accurate assessment of a business’s worth.
How to Calculate the Value of a Business Based on Turnover?
- Determine annual turnover using the last 12 months revenue or a 2-3 year average
- Identify the appropriate turnover multiple for the business’s industry and size
- Multiply annual turnover by the valuation multiple to calculate business value
Step 1: Determine annual turnover
To start calculating the value of a business based on turnover, you need to find the annual turnover figure. This is the total revenue generated by the business over a 12-month period.
You can use the most recent 12 months of revenue data, or calculate an average over the past 2-3 years. Using an average can help smooth out any temporary fluctuations and provide a more stable basis for valuation.
Example: Calculating average annual turnover
Let’s say a business had the following revenue figures:
- Year 1: $4.5 million
- Year 2: $5.2 million
- Year 3: $5.8 million
To calculate the average annual turnover:
($4.5M + $5.2M + $5.8M) ÷ 3 years = $5.17 million average annual turnover
Step 2: Identify the appropriate turnover multiple
The next step is to determine the turnover multiple that’s appropriate for the business’s industry and size. A turnover multiple, also known as a revenue multiple, is a valuation metric that indicates how much a business is worth as a multiple of its annual revenue.
Different industries have different typical turnover multiples, based on factors like growth potential, profitability, and risk. For example:
- Retail businesses might have a multiple of 0.5-1.5x
- Technology companies could be 3-5x or higher
- Professional services firms are often 1-2x
Company size also affects multiples, with larger businesses often commanding higher multiples than smaller ones.
- Business brokers and valuation firms
- Industry associations and trade publications
- Comparable company sales data
Step 3: Multiply turnover by the valuation multiple
Once you have the annual turnover and appropriate valuation multiple, calculating the business value is straightforward: simply multiply the two figures together.
Business value = Annual turnover × Valuation multiple
Example: Calculating business value based on turnover
Let’s value the example business from Step 1, which had a $5.17 million average annual turnover.
As a mid-sized professional services firm, an appropriate turnover multiple might be 1.5x.
$5.17 million turnover × 1.5 multiple = $7.76 million business valuation
Limitations of turnover-based valuation
While useful as a quick approximation, valuing a business based on turnover has some limitations:
- It doesn’t account for profitability. Two businesses with the same turnover could have very different profits and cash flow.
- Turnover multiples are general guides only. Every business is unique, so a more detailed valuation that considers its specific strengths and risk factors will be more accurate.
- Other valuation methods like discounted cash flow can provide additional insight, especially for high-growth or mature stable businesses.
Therefore, turnover-based valuation is a helpful starting point, but shouldn’t be relied upon in isolation. A comprehensive valuation will combine multiple methods to arrive at a fair market value range.
References: https://www.source.com https://www.nashadvisory.com.au/resource-centre/how-to-value-a-business-based-on-revenue https://www.bizbuysell.com/learning-center/article/value-business-based-revenue/ https://eqvista.com/value-business-on-revenue/
5 Factors Affecting How Much You Can Sell a Business for Based on Revenue
TL;DR:
- Industry benchmarks and growth trends impact business valuation
- High profit margins and diverse customer base boost value
- Recurring revenue is more valuable than one-off sales
Industry benchmarks
Typical revenue multiples vary significantly across different sectors. Tech companies often command higher multiples compared to retail businesses.
SaaS businesses with recurring revenue models can achieve multiples of 5-10x annual revenue, while traditional brick-and-mortar retailers may only fetch 1-2x revenue.
Factors driving higher multiples in tech
Tech companies often have:
- Scalable business models
- High growth potential
- Intellectual property assets
These factors justify higher valuation multiples compared to traditional businesses. As Mark Jones, partner at KPMG, notes, “Investors are willing to pay a premium for tech companies with proven ability to scale rapidly and capture market share.”
Revenue growth trends
Consistent year-over-year revenue growth can significantly increase the multiple a business sells for. Flat or declining revenue has the opposite effect, reducing the valuation multiple.
Acquirers pay top dollar for companies with strong and predictable revenue growth. A track record of 20%+ annual growth can easily double the multiple compared to a stagnant business.
Profitability and margins
Businesses with high profit margins are inherently worth more than those with slim margins. Ideally, aim for EBITDA margins of at least 15-25%.
Robert Davis, managing partner at BCG, advises, “Margin profile is a critical value driver. Companies with 30%+ EBITDA margins can command double the revenue multiple of a business barely breaking even.”
Why margins matter
Higher profit margins provide:
- Cash flow to reinvest in growth
- Cushion against revenue fluctuations
- Pricing power and competitive advantage
“Warren Buffett has long preached the importance of investing in companies with strong and durable economic moats,” notes Lisa Green, senior analyst at Morningstar. “High margins are often a telltale sign of a wide moat business.”
Customer concentration risk
A diversified customer base with no single client accounting for more than 5-10% of revenue enhances a company’s risk profile and valuation. Overreliance on a handful of key accounts has the opposite effect.
As Jeff Roberts, director at Grant Thornton, cautions, “Businesses with customer concentration risk often take a 20-30% haircut on valuation. Acquirers worry those key accounts could walk away post-acquisition.”
Recurring vs one-off revenue
Recurring revenue from long-term contracts or subscriptions is significantly more valuable than one-time project revenue. Recurring revenue is highly predictable and bankable.
“SaaS multiples have skyrocketed because investors prize their recurring revenue streams,” observes Kate Thompson, partner at Bain & Company. “A dollar of ARR is worth far more than a dollar of one-off sales.”
The power of recurring revenue
Recurring revenue offers:
- Predictable cash flows
- High customer lifetime value (LTV)
- Attractive unit economics
“The holy grail is achieving negative churn – when account expansions exceed losses,” remarks David Lee, partner at Bessemer Venture Partners. “Then your revenue growth becomes almost self-sustaining.”
References: https://www.divestopedia.com/definition/887/valuation-multiple https://www.mckinsey.com/industries/technology-media-and-telecommunications/our-insights/valuing-high-tech-companies https://www.investopedia.com/articles/financial-theory/11/valuing-startup-ventures.asp https://corporatefinanceinstitute.com/resources/valuation/valuation-multiples/ https://www.wallstreetprep.com/knowledge/valuation-multiples-analysis/ https://www.axial.net/forum/5-things-that-affect-the-value-of-your-company/ https://www.bainCapital.com/ideas/recurring-revenue-company-valuations/ https://www.forbes.com/sites/forbesbusinesscouncil/2022/07/07/how-vcs-value-startups-with-recurring-revenue/?sh=5d4e41737663
How Many Times Turnover is a Business Worth On Average?
- The value of a business is typically a multiple of its annual turnover
- The exact multiple varies by industry, ranging from 0.3x to 5x
- Factors like growth potential, assets, and profitability impact the multiple
When valuing a business, a common approach is to use a multiple of the company’s annual turnover (or revenue). This multiple can vary significantly depending on the industry, the company’s growth potential, and other factors.
Typical turnover valuation multiples by industry
Different industries have different average valuation multiples based on their unique characteristics, growth potential, and risk profiles. Here are some typical ranges:
- Tech companies: 3-5x
- Professional services: 1-2x
- Retail and hospitality: 0.5-1.5x
- Trades and construction: 0.3-1x
According to a 2021 study by Deal Focus Online, the median revenue multiple for software companies was 4.6x, while for construction firms it was just 0.6x. This highlights the significant variation across industries.
Factors impacting the valuation multiple
Beyond industry norms, several key factors can impact the specific multiple used to value a business:
Growth potential
Companies with strong growth prospects will command higher multiples. For example, a tech startup with a unique product and rapid user adoption may be valued at 5x revenue or more.
As Warren Buffett famously said, “Your premium brand had better be delivering something special, or it’s not going to get the business.”
Profitability
While revenue is the starting point, a company’s profitability also impacts its valuation. A business with high profit margins will be worth more than a similar-sized business with slimmer margins.
| Industry | Average Profit Margin |
|---|---|
| Tech | 20% |
| Retail | 5% |
| Construction | 10% |
Assets and intellectual property
Companies with valuable assets, like real estate, equipment, or intellectual property, will often fetch higher multiples. These assets provide a level of security and potential future value.
For example, a manufacturing company with $5M in annual revenue and $2M worth of equipment may fetch a higher multiple than a services business with the same revenue but few assets.
The 5x “Rule of Thumb”
One common “rule of thumb” is that a business is worth 5x its annual profit. However, this is a very rough guide and should be used with caution.
As business broker Mark Whitehead explains, “The 5x ‘rule’ is a decent starting point for relatively large, stable businesses. But for most small businesses, a lower multiple is more realistic given their higher risk.”
In summary, valuing a business based on turnover involves multiplying the annual revenue by an appropriate multiple. That multiple is heavily influenced by industry-specific norms as well as the company’s unique characteristics. While rules of thumb can provide a starting point, a thorough valuation will consider a range of factors to arrive at a fair market value.
Other Business Valuation Methods to Consider
- Explore alternative valuation methods beyond turnover multiples
- Understand the pros and cons of each method
- Learn when to apply different valuation techniques
While turnover multiples are a popular and straightforward way to value a business, they are not the only option. Different valuation methods can provide a more comprehensive view of a company’s worth, depending on its industry, size, and growth stage. Let’s take a closer look at some alternative valuation methods.
Earnings multiple valuation
Earnings multiple valuation is based on a multiple of net profits or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). This method is particularly useful for businesses with stable earnings and growth prospects. Multiples of 4-6x EBITDA are common, but they can vary depending on the industry and market conditions.
Advantages of earnings multiple valuation
- Focuses on profitability: Earnings multiples take into account a company’s ability to generate profits, which is a key driver of value.
- Industry-specific: Earnings multiples can be tailored to specific industries, allowing for more accurate comparisons between companies.
Disadvantages of earnings multiple valuation
- Sensitive to accounting practices: Earnings can be manipulated through creative accounting, which may distort the valuation.
- Short-term focus: Earnings multiples may not capture long-term growth potential or strategic value.
Discounted cash flow (DCF) valuation
DCF valuation estimates the present value of a company’s future cash flows. This method is particularly suitable for larger businesses with predictable cash flows and long-term growth prospects. DCF valuation involves forecasting future cash flows and discounting them back to the present using a discount rate that reflects the risk of the investment.
Advantages of DCF valuation
- Forward-looking: DCF valuation takes into account a company’s future cash generation potential, making it a more comprehensive approach.
- Flexibility: DCF models can be customized to incorporate different growth scenarios and risk factors.
Disadvantages of DCF valuation
- Complexity: DCF valuation requires detailed financial projections and assumptions, which can be challenging to develop accurately.
- Sensitivity to inputs: Small changes in assumptions, such as the discount rate or growth rates, can significantly impact the valuation.
For a deeper understanding of DCF valuation, consider reading “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company.
Asset valuation
Asset valuation calculates the fair market value of a company’s tangible and intangible assets. This method is often used for capital-intensive businesses or those in declining industries. Asset valuation can provide a floor value for a company, as it represents the value of its underlying assets.
Advantages of asset valuation
- Tangible basis: Asset valuation is based on the value of real, identifiable assets, which can provide a sense of security for investors.
- Suitable for asset-heavy businesses: Companies with significant tangible assets, such as real estate or machinery, can benefit from asset valuation.
Disadvantages of asset valuation
- Ignores future potential: Asset valuation does not account for a company’s future earnings or growth prospects.
- Difficulty valuing intangible assets: Intangible assets, such as intellectual property or brand value, can be challenging to value accurately.
Comparable company analysis (CCA)
CCA involves comparing a company’s valuation multiples to those of similar publicly traded companies. This method is based on the assumption that similar companies should trade at similar multiples. CCA is often used as a supplement to other valuation methods and can provide a market-based perspective on a company’s value.
Advantages of CCA
- Market-based: CCA reflects current market sentiment and investor expectations.
- Relative valuation: CCA allows for a direct comparison between companies in the same industry or with similar characteristics.
Disadvantages of CCA
- Limited comparability: Finding truly comparable companies can be challenging, especially for unique or niche businesses.
- Market inefficiencies: CCA assumes that the market is efficient and that comparable companies are valued correctly, which may not always be the case.
For more information on CCA and other market-based valuation methods, consider reading “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset” by Aswath Damodaran.
Venture capital method
The venture capital method is specifically designed for valuing early-stage startups and high-growth companies. This method involves estimating a company’s exit value (e.g., through an IPO or acquisition) and working backward to determine its current value. The venture capital method takes into account the high risk and potential rewards associated with investing in startups.
Advantages of the venture capital method
- Tailored to startups: The venture capital method is designed to value companies with high growth potential but limited historical financial data.
- Considers exit potential: This method focuses on the potential exit value of a company, which is a key consideration for startup investors.
Disadvantages of the venture capital method
- Highly speculative: Estimating a startup’s exit value is inherently uncertain and relies heavily on assumptions.
- Ignores near-term performance: The venture capital method may not adequately account for a startup’s current financial performance or cash flow.
For a comprehensive guide on startup valuation, consider reading “Venture Capital Valuation: Case Studies and Methodology” by Lorenzo Carver.
Conclusion
Each valuation method has its strengths and weaknesses, and the choice of method depends on the specific characteristics of the company being valued. By understanding the pros and cons of each method, investors and analysts can make more informed decisions about the value of a business.
Valuing Your Business: The Power of Turnover
Turnover is a quick and effective way to estimate your business’s worth. By multiplying your annual revenue by an industry-specific valuation multiple, you can gauge your company’s value in the current market.
However, factors like revenue growth, profitability, customer concentration, and recurring revenue also impact your valuation. Comparing typical multiples across sectors can give you a sense of where your business stands.
Ready to sell your business or seek investment? Start by calculating your valuation based on turnover. Then explore other methods like earnings multiples, discounted cash flow, or asset valuation for a more comprehensive view.
What’s the next milestone for your business? Whether it’s reaching a revenue target, diversifying your customer base, or improving margins, understanding your company’s value can help you make informed decisions and negotiate with confidence.
