DO ‘RULES OF THUMB’ WORK FOR BUSINESS VALUATIONS?

Rules of Thumb are used every day to help business owners place a sales value on their business. These “rules” are quick, simple and easy to apply; however, they are only the beginning in the process of determining a business value.

Many of these rules belong in one of two categories:

• A multiple of gross revenues (sales)
• A multiple of earnings (net income, cash flow, EBITDA)

The value derived from these “rules” is the value of the operating assets of the business plus goodwill. The price does not include cash, accounts receivable, work in process, prepaid expenses and real estate; these will be retained by the seller. It also assumes that the business will be free and clear of all debt and accounts payable; these will be paid by the seller.

Business Valuation Resources has identified “rules” multiples of gross revenues for major industry groups in recent years:

Industry                     2008           2009          2010

Construction              0.39            0.40           0.35

Manufacturing           0.53            0.61           0.52

Transportation           0.69            0.43           0.55

Wholesale Trade       0.46            0.45           0.52

Retail Trade               0.36            0.33           0.34

Services                     0.56            0.53           0.56

These “rules” are very useful tools; however, they are often misunderstood and misapplied.