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Times-Revenue Method Definition
The times-revenue method refers to a method of valuing a company. It applies multiples to current revenues to arrive at a valuation.
A Little More on What is the Times-Revenue Method
Times revenue method is popular among individuals who own small businesses. They use it when they want to determine the value of their companies so that they can ensure:
- Proper financial planning
- Proper preparation before they sell the business
However, calculating the value of a business can sometimes be challenging, especially where prospective future revenue is the one determining the value. So, to facilitate business decisions, there are a number of models that companies use to determine a range of value.
Note that the value of the multiple may vary depending on the method employed for revenue measurement or the consideration period of revenue. Some analysts use recorded sales or revenues sales on Pro-forma financial statements to show how future sales will look. Note that it is the industry that determines the multiplier analysts use to do a business valuation. When it comes to small business valuation, more focus is on:
- Finding a floor (the lowest price) an individual would pay for a business. The floor price refers to the liquidation value of assets a business owns
- Determining a ceiling (maximum price) that an individual is likely to pay, like multiple of current revenues.
As soon as you are through with calculating both the floor and ceiling prices, you can now determine the value an individual is willing to pay to acquire the business. There are a number of factors that influence the value of multiples individuals use to evaluate the company. The methods may include the industry conditions, macroeconomic environment, among others.
How it Works (Example)
Let’s assume that XYZ Company’s current revenue is $1 million. To calculate the maximum sales revenue for determining the XYZ Company value, you will use the times-revenue method to achieve this. Typically, valuing of business is determined by one-times sales, within a given range, and two times the sales revenue. What this means is that the valuing of the company can be between $1 million and $2 million, which depends on the selected multiple.
Let’s assume that the revenue for ABC’s Corporation over the past twelve months was $100,000. Using the times-revenue method, the valuation of the ABC corporation will be somewhere between $50,000 and$200,000. The $50,000 is termed as half times revenue, while $200,000 is two times revenue.
How Useful is the Times Revenue Method?
The times-revenue method is beneficial when it comes to measuring the buyer’s purchase price offer. The multiple’s values may vary depending on the method of revenue measurement in use or the period taken to consider it. You can use a 12-months method to measure revenue, based on the actual activity of the company’s historical performance. You can also use what we call Pro-forma statements to do the accountability of actual sales or future predictions.
Times-Revenue Method Application
- The times-revenue method is suitable for new business with either very volatile earnings or non-existent earnings.
- The method is also ideal for those companies that seem to grow fast. A good example is the software service firms.
Also, the multiple users are likely to be higher in case an industry or a firm is set for expansion or growth. Note that there is an expectation to these firms experiencing things such as a growth face that is high with recurring revenue in high percentage and good margins. The valuation of this will have a revenue range of between three to four times.
However, there is a multiplier that is likely not to show any significant growth potential or is closer to a slow-growing business. A firm that has recurring revenue percentage that is low as a service company, its valuation, is likely to be at 0.5 times revenue.
Advantages of Times Revenue Method
The Times revenue method has one major advantage. It is used in financial analysis, especially when the independent variable is the revenue, and the manipulation of other parameters’ values is for sensitivity analysis.
However, note that for valuation purposes, the method may not be that accurate. The reason is that an increase in revenues does not necessarily mean an increase in profitability.
Times-Revenue Method Limitations
One major limitation of the time revenue method is that it is not an indicator you can rely on to determine a company’s valuation. The reason is that revenue does not actually mean profit. The same way, revenue increase, does not mean an increase in profits.
Note that to be able to come up with an accurate company’s current actual value, you must factor in earnings. So, the earnings’ multiple or earnings’ multiplier is much better when you compare it to multiples of the revenue method.