Four Major Factors That Determine the Value of a Company

Truforte Business Group - Brokers Blog

When Determining the Value of a Business

There are a number of different methods of company valuation. In this post, we will go into a little more detail about which factors influence the valuation of a company.

Many times company values are based on EBITDA. EBITDA is the abbreviation for “Earnings before interest, taxes, depreciation, and amortization” and is a measure of a company’s financial performance before interest, taxes, depreciation, and amortization. It reflects the operating cash flow, regardless of the capital structure and tax framework.

The hard part of the evaluation is setting the multiples. For small and medium-sized companies, the spectrum ranges from 2 to 4x at the low end to 6 to 8x at the top. So which factors determine whether a company is valued at four times or eight times EBITDA? When talking about multiples it is important to note that EBITDA is not the same thing as “Owner Benefit” or “Discretionary Earnings” and the multiples on those numbers are usually significantly lower. Here is a brief overview of the most important influencing factors:

Supply and demand

Companies in attractive industries with high demand, such as technology companies, are generally rated higher than others. But the supply side also plays a role. If a particularly large number of well-managed and profitable companies are up for sale, the multipliers, and thus the prices, decrease due to the oversupply. On the other hand, if many prospective buyers are bidding on a handful of companies, the multiplier increases. It is, therefore, worthwhile to analyze the market situation to find the optimal time to sell a company.

Growth potential

A company valuation is based on the EBITDA of the last three years. What interests the buyer, however, is how much the business will generate in the future. Therefore: the greater the growth potential, the higher the multiplier.

Risk

Risk can take different forms: A high customer concentration, for example, increases the dependency on the solvency of individual buyers. In the case of technology companies, there is a risk that developments by competitors will prevail as the standard and that their digital products will become obsolete. The higher investors estimate the risk, the higher the return they expect and the less willing they are to pay to buy a company. A high risk, therefore, reduces the multiplier.

Volatility

Volatility is closely related to risk. Companies whose income fluctuates significantly are considered risky because it is difficult to forecast expected revenue. Accordingly, such companies are rated with lower multipliers. Investors prefer companies with long-term contracts and stable revenues. To get expert help valuating your business, get in touch with us today or read more about what your company in Florida is worth and check out the top valuation methods here. Also see some of the FAQs about buying a Florida business.

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