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6 Factors that Determine Your Company’s Valuation

by janeausten

A company valuation is more than a discounted cash flow calculation. The exercise can be done by the owner of a business, their management team, or a third-party appraiser. It requires an in-depth examination of the company’s balance sheet and customer base to determine its fair market value.

There are many valuation methods for business valuation. There are many different approaches to business valuation. Some may value income more than others, while some may value “market value,” based on the past sales of similar assets. The truth is that your company is worth whatever price someone is willing to pay.

A variety of factors are usually considered when valuing an existing business. Here are six of the most popular.

  • EBITDA

The old saying “size matters” is a key factor in determining the appropriate EBITDA multiple for your business. Larger companies tend to attract more EBITDA multiples, so larger deals will be worth more.

  • Trends In Revenue

Potential buyers pay attention to the revenue trends of small businesses when assessing their value. A premium will be paid for small businesses that consistently outperform the market in terms of past and projected revenue growth. Businesses with declining, subpar or flat revenues will be paid a lower market EBITDA multiple.

Remember that not all revenue increases are equal. Businesses with recurring revenue growth will trade at higher multiples than those with revenue increases due to one-off initiatives. Because recurring revenue provides more predictable, consistent, and steady cash flows than project-based revenues, this is why it is so attractive to trade at higher multiples.

  • Profit Margin

As a guideline, companies with high gross margins are more likely to be valued. A company with strong gross margins is likely to have a competitive advantage through unique distribution channels and valuable offerings. Because each dollar of revenue is more profitable than average, this usually leads to a higher EBITDA multiple.

  • Concentration on Industry

Concentrated revenues in one market can make companies more vulnerable to sector-specific variables outside their control. This includes the introduction of new rules and disruptive technology, increased competition, and the cyclical nature of the market. However, sometimes industry specialization can prove beneficial. A company that serves an end market growing faster than GDP might be able to fetch a higher EBITDA multiple. The current growth rates of plastics, aerospace, and medical are faster than that of GDP.

This article may interest you: Top Ten Reasons to Value Your Business in 2023

  • Strength and depth of the Management Team

Smaller businesses often rely too heavily on their CEO/Owner’s entrepreneurial skills, which may have a significant impact on more than one area. These scenarios are common, but over-reliance on one person can lead to increased risk to the business or perception of increased risk to the business. A company with an outstanding management team, including individuals who excel in core areas such as Sales, Marketing, Finance, Engineering, and Operations, is more likely to be valued by the market.

  • Customer Concentration

Enterprise Value is affected by client concentration. Companies with significant client concentration (defined as any one customer that accounts for more than 20% or three customers who account for more than 50% of annual revenue) have lower EBITDA multiples than companies with similar revenues and profitability, but with a wider customer base. For example, acting as a single source supplier and/or having long-term agreements that are beneficial to significant clients can help resolve potential buyers’ concerns about a client base.

These are two bonus points that you can enjoy as a bonus:

Sustainable Competitive

Advantages are designed to protect the business against potential infiltration by competitors, thereby decreasing business risk and increasing growth prospects. Business buyers will pay a premium multiple if a company has strong competitive advantages, such as intellectual properties, unique capabilities, services, or proprietary processes.

These competitive advantages often manifest themselves in financial success for a company, since enterprises can charge higher prices (and customers will pay more) for unique value-added products or services.

Reputation

Your reputation and goodwill in your community could be very important. Although it can be difficult for you to value this intangible asset, it is still extremely valuable. An excellent reputation can significantly increase the value of your business, while a bad reputation can hurt your chances of selling it.

There are many factors to consider when determining the value of a company that is being bought or sold. Contact Arrowfish Consulting to learn how we can help you through the entire transaction while protecting your best interests.

Wrapping it all

Business valuation is not a science. The elements that impact Enterprise Value are not intended to be exhaustive. Recognizing and measuring the essential elements of company valuation can help one business owner build realistic expectations about the business’s value.

Arrowfish Consulting is reliable, efficient, and easy to work with when it comes to business evaluation and valuation services. Our company appraisers have years of experience and are considered industry experts.

Contact us if you have any questions or would like to learn more about how these factors may impact the value of your business.

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