Introduction: When you should use these rules of thumb
Valuing a company can be complex, but there are simple rules of thumb that can serve as an initial guide. These rules of thumb help SMEs in particular to quickly and easily arrive at a rough estimate of their company value. At the end of the article, we give you further tips and advice if you would like to delve deeper into company valuation.
Rule of thumb no. 1: Companies evaluate using the revenue multiplier
One of the simplest methods and a popular rule of thumb for calculating the company value takes turnover as the starting point. The so-called revenue multiplier formula is based on the assumption that the company value is a multiple of the annual turnover.
Formula: Enterprise value = annual turnover x multiplier
Example: A company with an annual turnover of 1 million euros and a multiplier of 2 has an estimated value of 2 million euros.
The multiplier varies depending on the industry, market situation and specific company characteristics. Typical multipliers are between 0.5 and 3.
The revenue multiplier method is particularly useful in sectors with stable sales and low fluctuations, such as retail or service companies. This rule of thumb is easy to apply and quickly provides a rough estimate of the company’s value. It is well suited to companies that do not yet have comprehensive financial data or whose profits fluctuate greatly.
However, it should be noted that the multiplier varies depending on the sector and market situation and that careful selection of the right multiplier is crucial. In addition, this method does not take into account the profitability or debt of the company, which can lead to a distorted valuation. Therefore, the revenue multiple method should ideally be used in combination with other valuation methods to obtain a more comprehensive picture of the company’s value.
Rule of thumb no. 2: EBIT multiplier for calculating enterprise value
A slightly more precise method is the EBIT multiplier method. This rule of thumb takes into account operating earnings before interest and taxes (EBIT) and applies a multiplier to calculate the enterprise value.
Formula: Enterprise value = EBIT x multiplier
Example: A company with an EBIT of EUR 200,000 and a multiplier of 5 has an estimated value of EUR 1 million.
The multiplier can vary greatly depending on the sector and risk profile of the company, but is typically between 4 and 10.
However, in our experience, with a clever strategy, a solidly managed company can also achieve significantly higher multiples. We have summarized some initial impulses for you in a separate article, which you can read here here. If you require further advice, please send us a short message using our contact form.
Excursus: Reading and calculating EBIT from the BWA
You can read the EBIT (Earnings Before Interest and Taxes) from your business analysis (BWA), which is provided to you by your tax office or your internal finance department. If the EBIT is not already shown there directly, you will find all the key figures you need to calculate the EBIT in the BWA:
- Start with the net income or net loss for the year.
- Add the interest paid (you will find this under financing costs).
- Add the taxes paid (may be listed under “other expenses”).
To put it simply, you only deduct the items “interest” and “taxes” from the net profit or loss for the year.
Formula:
EBIT = Jahresüberschuss (bzw. Jahresfehlbetrag) + Zinsen + Steuern
Example:
- Net profit for the year: 150,000 euros
- Interest: 20,000 euros
- Taxes: 30,000 euros
EBIT = 150.000 Euro + 20.000 Euro + 30.000 Euro = 200.000 EuroRule of thumb no. 3: The net asset value method for the company value
If the first two rules of thumb for your company do not yet provide a good starting point for calculating the company value, the net asset value method could be of interest to you: It also allows you to calculate the company value using a simple formula. However, it focuses on the tangible value of the company’s assets and deducts the debts in order to calculate the net value of the company.
Formula: Enterprise value = total assets – total liabilities
Example: A company has assets worth 500,000 euros and debts of 100,000 euros. The enterprise value is therefore 400,000 euros.
This method is particularly suitable for companies with high tangible assets, such as real estate or machinery. These can be real estate companies, production companies or companies in the mechanical engineering sector. Using the net asset value method can therefore make sense if the majority of the company’s value lies in tangible assets and less in intangible assets such as brand value or customer base.
However, it is important to note that this method does not take future earnings potential into account and is therefore less suitable for high-growth companies. In addition, the precise valuation of assets and liabilities can be complex and time-consuming. Therefore, the net asset value method should also be used in combination with other valuation methods to ensure a more comprehensive and accurate valuation of the company.
The formulas provide very different company valuations… what now?
The use of different rules of thumb to calculate the value of a company can lead to different results. This is because each method takes different aspects and assumptions into account. The sales multiplier method focuses on sales, while the EBIT multiplier method includes operating earnings before interest and taxes. The net asset value method, on the other hand, values the company’s tangible assets.
What should you do if the ratings vary widely? First, it is important to understand the specific strengths and weaknesses of each method. None of the rules of thumb alone are sufficient to provide an accurate assessment. Instead, you should compare the results of the different methods and consider averaging them.
Under this link you will find a more detailed guide on how to calculate goodwill using formulas and understand the various influencing factors in more detail.
It is also advisable to seek professional advice. An experienced M&A advisor can help you interpret the different valuations and make an informed decision. In this way, you can ensure that you determine the most realistic and appropriate value for your company.
Practical examples of company valuation with rules of thumb
As just described, the application of the three rules of thumb for calculating goodwill often leads to very different results. In order to better illustrate the fit of the formulas and their different focuses, we will now present two case studies. These examples illustrate how the sales multiplier method, the EBIT multiplier method and the net asset value method can be used in real scenarios and show which values are determined for a fictitious retail company and a manufacturing company.
Case study 1: Retail company Müller GmbH
Müller GmbH is a medium-sized retail company with a stable annual turnover of 2 million euros, an EBIT of 250,000 euros and assets worth 800,000 euros. The company’s debts amount to 200,000 euros. We calculate the company value using our three rules of thumb:
| Sales multiplier | Formula: Enterprise value = annual turnover x multiplier Multiplier: 1.5 (value customary for the retail sector) Calculation: 2,000,000 euros x 1.5 = 3,000,000 euros |
| EBIT multiplier | Formula: Enterprise value = EBIT x multiplier Multiplier: 6 (customary value for the retail sector) Calculation: 250,000 euros x 6 = 1,500,000 euros |
| Net asset value | Formula: Enterprise value = total assets – total liabilities Calculation: 800,000 euros – 200,000 euros = 600,000 euros |
The sales multiplier method delivers the highest value (EUR 3,000,000), followed by the EBIT multiplier method (EUR 1,500,000) and the net asset value method (EUR 600,000).
Case study 2: Production company Schmidt AG
Schmidt AG is a medium-sized production company with an annual turnover of 5 million euros, an EBIT of 500,000 euros and assets worth 3 million euros. The company’s debts amount to 1 million euros. We calculate the goodwill using the three formulas as follows:
| Sales multiplier | Formula: Company value = annual turnover x multiplier Multiplier: 1 (standard industry value for production companies) Calculation: 5,000,000 euros x 1 = 5,000,000 euros |
| EBIT multiplier | Formula: Enterprise value = EBIT x multiplier Multiplier: 8 (standard industry value for production companies) Calculation: 500,000 euros x 8 = 4,000,000 euros |
| Net asset value | Formula: Enterprise value = total assets – total liabilities Calculation: 3,000,000 euros – 1,000,000 euros = 2,000,000 euros |
Here, too, there is a clear discrepancy between the methods. The sales multiple method values the company the highest (EUR 5,000,000), followed by the EBIT multiple method (EUR 4,000,000) and the net asset value method (EUR 2,000,000).
These case studies illustrate that the choice of valuation method has a significant influence on the result and that a combination of different approaches can lead to a more balanced valuation.
Summary & outlook
The above-mentioned rules of thumb offer simple and quick ways to obtain an initial estimate of the company’s value. However, it is important to emphasize that these methods should only be used as a starting point. A detailed and professional valuation takes into account many other factors, including future earnings prospects, market conditions and risks specific to the company.
For a well-founded assessment, we recommend seeking professional advice.
If you would like to find out more about the valuation of your company, visit our blog for more helpful articles and expert opinions. If you have any specific questions, please do not hesitate to contact us. Simply send us a message using the feedback form directly below this article.
