Business Brokers BC Blog

How do you determine the value of a company?

Thursday, January 27th, 2011

The rule of thumb for calculating value is taking a multiple of either cash flow, or Earnings Before Interest, Taxes, Depreciation, and Amortization (also called EBITDA).

What is the difference?

Cash flow multiples are used most often to value a business when there is an owner/operator in place.  (However, be careful as cash flow is a generic term used differently depending on the context. It may be defined by users for their own purposes.  Similar to Working Capital which must also be carefully defined when transferring the Balance Sheet at closing).

EBITDA is used more often when a financial or strategic buyer is involved and is more of a reflection of what an investment in the purchase of a business will return with absentee ownership in place (similar to how a property investor would look at Net Operating Income).

Regardless of which of the above approaches used a significant element in the pricing of any business is the quality of the cash flow and the potential growth of your cash flow.  A track record of significant repeat business (say 50% to 60%) is very attractive.  Naturally good growth also receives higher premiums.

When it comes to what multiples to use, this is best determined by looking at market data and seeing what comparable companies have recently sold at.  Typically the multiples used for evaluations using EBITDA would be in the region of 5 times, while the smaller cash flow based businesses would sell for a lesser multiple (oftentimes around 2.5 times).

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