Valuation of a Company
For a precise business valuation service, more than EBITDA counts
The accurate valuation of a company involves more than meets the eye. We are frequently asked which ‘multiple’ is the right one with which to assess the value of a business, whether it be a large or small business valuation. Most business owners then volunteer that the EBITDA multiple (Earnings Before Interest, Tax, Depreciation, Amortization) is the best single criteria. However, only relying on earnings can be short sighted.
Valuing a business requires a wide scope approach. EBITDA, by its definition removes the elements of financing and accounting decisions by adding back interest, depreciation and amortization and thus, can be used to compare the profitability between companies and industries. Further, it can analyze industry trends over time.
However for the valuation of a company, EBITDA is not always a good measurement for cash flow, even though cash flow is the most vital component for small and midsized businesses survival. Operating Cash Flow is a much better criteria for assessing cash flow since it includes the changes in working capital, most significantly A/R, inventory and A/P. A comprehensive large or small business valuation will address this.
For example, relying only on EBITDA as value measurement (which many low level sample business valuation reports do), an analysis could easily neglect to find an inventory built-up due to poor product design, resulting in an increased need for financing or future margin erosion due to required discounting. Additionally, the need for more working capital as accounts receivable increase, can cause a significant drain on cash, particularly for seasonal businesses.
Valuation of a company is essential for planning, selling and financing
Generally, there is no single “rule of thumb” by which to arrive at the valuation of a company. Indeed, we caution our clients not to use popular ratios such as 50% of annual sales for liquor stores, 1.1 times revenue for accounting firms, 60% of revenue for dental practices or 3 times for software companies. These are inaccurate “guesstimates” that can be alarmingly different from the results of an accredited business valuation.
Most professional valuation associations do not even recognize these rules of thumb as legitimate valuation methodologies. Large databases of market comparables, such as Pratt’s Stats, BIZCOMPS or the one of our firm uses, provide a basis for a much more qualified approach to the valuation of a business.
Typically, a professional business valuation service is based on numerous criteria, such as an Asset Based Approach, Income Based Approach and Market Based Approach, whereas each approach has several sub-criteria to establish a value. The business valuation firms we work with usually take at least eight different key components into account when developing an accredited business valuation assessment. Each is then weighed based on its respective merit to arrive at a Fair Market Value for the business.
Only such a detailed approach will provide a business seller not only with a Fair Market Value for his own decision making, but also establish credibility for the asking price with a potential buyer, as well as with lending institutions funding the acquisition for the buyer. Omitting such a professional business valuation service will ultimately hurt a seller in more than one way.
Contact A Neumann & Associates, LLC
If you are considering selling your business, please contact us to learn more about our comprehensive service spectrum. Our experienced professionals will answer all your questions about selling a privately held business in complete confidentiality. Please to fill out a short form, or call us at (732) 872-6777. We will contact you directly and will never identify ourselves to your employees.