Valuing a Business Based on Its Revenue
If you need to benchmark a business's value, it's not necessary to conduct a full-blown appraisal. There are "rules of thumb" approaches that will return reasonable estimates that serve as a starting point for business valuation and pricing.
Using revenue as the basis for valuing a business is a valid approach, but the analysis must consider bottom-line profit or owner discretionary earnings. In this article, we will go over the times-revenue method of business valuation, its limitations, and how (and when) to use it.
How to Value a Business Based on Revenue
Whether you are buying the business, selling it, conducting a valuation for financing, or exit planning, using revenue as the basis for valuation is a good place to start. The calculation is straightforward and simple – just multiply the businesses revenue by a suitable pricing multiple.
But what multiple? And what's included in revenue?
Revenue vs. Sales
For most businesses, revenue and sales are the same thing. It's the total amount of money collected from customers. For some larger businesses though, there may be other income from non-operating sources like investment dividends or interest earnings. Revenue includes all sources, while sales include only operating sources. For this article's purposes, we will skip that distinction and focus on operating revenue.
Valuations attempt to predict future finances by looking at past performance. With that in mind, it’s common to take an average of the past three years revenue as a basis for the calculation.
What Multiple?
Getting the right multiple is the tricky part of the times-revenue method. Ideally, we would have access to the sales price and financial information of similar businesses that have recently sold, but that is not usually readily available. Most sales of private businesses are transacted confidentially, so the details are not in the public domain.
The next best thing is to use industry averages. The average revenue multiple of businesses sold on BizBuySell is about 0.6 – so the average business sells for around 60% of annual revenue.
Going one step further, we can look at revenue multiples for distinct types of business. Restaurants, for example, sell for an average of about 0.4 times annual revenue, while breweries sell for nearly 0.7 times revenue. Some other notable disparities:
- Gas stations (0.46) vs. car washes (1.88)
- Software/app companies (1.68) vs. software service/IT (0.95)
- Car dealerships (0.42) vs. towing companies (0.86)
- Grocery stores (0.33) vs vending machine businesses (1.10)
As you can see, revenue multiples can vary quite a bit between different types of businesses. For a complete list of industries and sectors, see our revenue multiple tables.
Assumptions and Limitations
While using revenue as a metric for valuing a business is a decent starting point, it assumes that the business is operating at the industry average profit margin, and that is a big assumption. While similar businesses may have a comparable bottom line, it's certainly not guaranteed, or even expected.
Let's consider two gas stations operating on different corners of the same intersection. Both have annual sales of $1,000,000. Gas station 1 spends $1,000,000 a year on operating costs (rent, wages, fuel, etc.) and gas station 2 spends $800,000.
Would you pay the same price to buy gas station 1, which will earn you $0, as one that would earn you $200,000 a year? Of course not.
That's why every valuation must include an analysis of the business's bottom line. Business buyers are interested in how much a business will bring its owner after all the expenses. The result is market valuations that hinge primarily on earnings, as opposed to revenue or sales.
To read more about profit-based valuation as well as other common valuation methods, see our Guide, How to Value a Business.
Why Focus on Revenue?
Revenue-based business valuations are a helpful tool as long as the overall valuation analysis considers net income or discretionary earnings.
That said, business buyers (and as such, sellers) may lean on revenue-based valuation if they believe they have levers available to reduce expenses and improve business earnings. For example, the owner of gas station 2 above may have access to more favorable pricing on fuel and goods or may be able to renegotiate the lease terms.
A business buyer may have the tools and experience needed to improve the performance of a business, and as such may be willing to pay a slight premium over an earnings-based valuation for the sales volume. Keyword, slight. Bottom-line earnings will always trump revenue when it comes to business valuation.
To learn more about how businesses are valued and priced in the business-for-sale market, see our section on Business Valuation. If you are interested in buying or selling a business, be sure to create a free BizBuySell account to set up saved listings and searches, run valuation reports, and stay on top of your market.