How to solve issues with company value based on revenue
Company valuation is a necessary process for businesses and financial institutions alike. Through this, the economic value of an entire enterprise or a smaller business unit is determined. This process is essential for a variety of purposes such as its selling value, disclosure for partner ownership, and even for equitable distribution for divorce proceedings.
However, there are instances where determining a company value encounters a problem, a discrepancy, or any other issues. Aside from the risks of under or overvaluation, company value is an important resource that you and your team could leverage in making deals or in securing financing.
To help you maintain an accurate figure, here’s how you can resolve certain issues regarding company value based on revenue.
Understanding company valuation based on revenue
First, it’s important to recognize that there are different methods for determining the value of a company or a business unit. One of these methods, the times-revenue method, is a technique used to identify the “ceiling” or the maximum value of the company in question. It relies on a multiple of the business’ set of recent revenues. Depending on a host of different factors such as the industry the business is in or the local economic conditions, this multiple might be up to twice the actual revenue figures. However, there are certain industries where the average multiple is less than one.
Similarly, others rely on a strategy called the enterprise value-to-revenue multiple. Also known as the enterprise value-to-sales multiple, this method is more commonly applied to companies being assessed as a part of a potential merger or acquisition. It is used to check the value of a stock by comparing revenues to the enterprise value to see if it was fairly priced. A lower enterprise value-to-revenue ratio means that the company is undervalued.
Resolving issues from revenue-base company value
Common issues from company value may come from a range of factors, from faulty stock level adjustments to disagreements from sale prices based on revenue and other financial performance metrics.
To help you avoid these common problems, and solve them if you have them, we’ve listed a few common sources for company valuation disputes.
In some methodologies, such as by determining the enterprise value-to-revenue multiple, it is imperative that comparisons be made between companies in the same industry. Comparing entities from different industries could lead to an inaccurate valuation of the company. For example, take a consultation firm against a restaurant. Consulting is an industry that sees an average profit margin growth of 80% or more while among restaurants, a margin increase of 10% is already considered healthy.
In this method, the benchmark has to be the best-in-breed in the same industry to determine whether the company being valued has a good or poor performance. The same goes for other valuation methods that require the use of a benchmark company to assess the value of another; the two companies have to be as similar as possible to eliminate factors that add to the inaccuracy.
Stock level adjustments
Some businesses fail to keep accurate assessments and records of the amount of stock they have. This failure to maintain a good stocktake will come back to bite the company once it goes up for sale. Chances are the financial records could indicate a number of stocks different than they actually have.
This leads to an issue in the turnover of the company after the acquisition. The old owners might be going after their investment in the disputed stock and would include it in the reports and the valuation of the company. However, new owners might lean towards simply writing those old stocks written off since they might be hard to sell or even unaccounted for.
If no compromise is met between the parties involved, then there’s no way to resolve this but by tracing the stocks being contested. It’s a painstakingly tedious procedure and for the sake of convenience and pushing the deal through, it’s easier to just write them off.
Evaluating financial performance
One of the most common indicators of how well a business is doing is through observing profit and the use of other profitability ratios. In company valuations, it is multiplied with other factors depending on the method used to generate a fair value for the assessed enterprise or business unit. Aside from the method used, the multiple also changes depending on the size of the company and the identified future risks. Even the overall projections in the industry where the business belongs could affect future expectations.
Disputes in this matter usually come from the identification of different profits. There are instances where managers or business owners inflate their wages, affecting company funds that could otherwise be declared as profit. In the event of a disagreement, it’s better to refer to a third-party expert to conduct a separate valuation of the company to resolve the issue.