5 Quick Calculation Methods to Determine the Value of a Company
Which 5 efficient calculation methods are commonly used to quickly determine the value of a company?
When buying, selling, or investing in a company, it is essential to determine the company's value. There are various methods to calculate a company's value, some of which are faster and simpler than others. While other pages on this site cover more complex valuation methods for startups, this page will focus on five quick valuation methods for more mature companies based on the following financial variables from the annual report: annual revenue, intrinsic value, net profit, EBITDA, and EBIT.
Efficiently determining a company's value can be achieved by using formulas commonly applied in practice. The use of these formulas is particularly useful for small and medium-sized enterprises seeking quick insights into their value. This swift valuation enables companies to make faster decisions, such as in acquisitions or the sale of the business. The commonly used formulas are:
- Value = 0.5 - 5 times the annual revenue;
- Value = 1 time the intrinsic value;
- Value = 4 - 6 times the net profit;
- Value = 3 times EBITDA (earnings before interest, taxes, depreciation, and amortization);
- Value = 4 times EBIT (earnings before interest and taxes);
While this list can be complemented with other values and variables, there is often industry consensus on which rule of thumb applies. It is important to emphasize that these rules of thumb do not represent a universally valid 'truth' but rather serve as guidelines based on past experiences. Additionally, the value depends on the industry; for instance, a law firm may be worth more than a garage with the same revenue. Therefore, considering the specific circumstances of the company and its operating industry is crucial in valuation methods.
The annual revenue method is a quick way to estimate a company's value based on its annual revenue. The concept is that a company generating more revenue is generally more valuable than a company generating less revenue. The annual revenue is multiplied by a specific factor, often using the factor 3, to determine the company's value. However, this method is limited as it does not consider other important factors such as costs, market conditions, margins, and growth potential.
The intrinsic value method takes into account the assets and liabilities of a company to calculate its value. The idea is that the value of a company equals the sum of the value of all its assets minus the value of all its liabilities. In some cases, 1 or 2 times the net profit may also be added to the intrinsic value. While this is a quick and straightforward method, it may be too restrictive as it does not consider future income streams (expected to increase) or the market value of assets.
The net profit method is a variation of the annual revenue method, calculating the value of a company based on its net profit. The notion is that companies with higher profits are generally more valuable than those with lower profits. The net profit is multiplied by a specific factor, often using the factor 5, to determine the company's value. However, this method is limited as it does not consider other factors such as future growth or the relationship between profit and costs.
The EBITDA method calculates the value of a company based on its EBITDA, i.e., earnings before interest, taxes, depreciation, and amortization. A multiplier of 3 is typically used. This method is often employed in valuing companies in the tech and software industry, where significant investments are made in intangible assets. However, this method is also limited as it does not consider other important factors such as cash flow and the company's growth potential.
The EBIT method calculates the value of a company based on its EBIT, i.e., earnings before interest and taxes. A multiplier of 4 is typically used. This method is similar to the EBITDA method but does not consider depreciation and amortization. While useful for valuing companies with few intangible assets, it may be limited as it does not consider other critical factors such as growth potential and cash flow.
When applying these calculation methods to a specific company, you will notice significant variations in the valuation. There can be considerable differences between the outcomes of these calculation methods. Therefore, these methods are intended as an initial indication and should never be considered an official guideline or valuation. They can only be used as a starting point for further analysis and research with more advanced valuation methods. Let's begin with the simplest one: the cost method.