When you're trying to determine the valuation of a company for any number of purposes, you may hear the term valuation multiples tossed around. But what is it, how does it affect business appraisals and when should a different approach be used? Let's take a look at this company appraisal process:
What are valuation multiples?
Valuation multiples is a business appraisal method that can very quickly evaluate a business based on similar businesses, while still adjusting for differences before determining a business valuation appropriate to the company. In the most basic sense, a valuation multiple shows market value as it relates to a key statistic that shows that value. It's usually in one of two forms, as a percentage of sales or a multiple of earnings.
How it can affect a business valuation?
A valuation multiple provides the information that prospective investors with a valuation based on comparable sales. It's a fairly simple model, making it much more user-friendly in terms of understanding where the numbers are coming from, and it provides a useful tool to measure the fair market value in a simple fashion. These valuation multiples are obtained from databases of transactions. Business valuation professionals subscribe to these databases so that they have access to current and historic business sales. The data is mined to find closely related business and then statistics is used to find which multiple should be used for the data set. The multiple with the lowest coefficient of variation is typically the multiple that is used.
What if there are circumstances that require a different approach to company valuation?
Is your busines in an evolving industry, possibly in a high growth technology field? If you're concerned that a basic valuation multiple appraisal won't give you an accurate figure, it may be better to have a thorough company appraisal performed to generate a more accurate analysis. The discounted cash flow method, which is an income approach to valuation, is typically used for these situations. Though valuation multiples are easy to understand and use sales comparisions as a basis, it isn't the one-shoe-fits-all methodology.
Whether you're selling your business, considering selling off a portion of your operation or are thinking about acquiring a new operation to expand your business concerns, having a solid business appraisal ensures you know what you're getting. Make sure to use a valuation company with a reputation for excellence to prevent costly mistakes in your business plans.