As a business owner, understanding how your business is valued is essential for making informed decisions when selling your business. Business valuations rely on various formulas that weigh factors such as profitability, market comparisons with similar businesses, and a “business score” that evaluates intangible assets. Valuators use these formulas and apply an industry-specific multiplier to reach a valuation figure.

The most fundamental formula is:
Business Cash Flow x Industry Multiple = Business Value Number
At first glance, this formula may seem overly simplistic. You might wonder, “What about the value of my website or my email list?” The common mistake is evaluating these components separately. Business valuation doesn’t work in isolation. Instead, profitability and cash flow are assessed as a whole to reflect the business’s overall revenue generation. The market views your business as an interconnected system working together to produce profit. Profitability is always considered first, before delving into the details of your business’s individual components.

Why Some Business Owners Get Confused
It’s not uncommon for business owners like you to feel confused by the different valuation methods. Potential buyers often introduce their own risk assessments when determining how much they are willing to pay for a business. This perception of risk can affect the price a buyer is willing to offer, which may differ from the value determined by professional business valuators. Because valuators do not account for buyer-specific risk, this can lead to valuation numbers that don’t align with your expectations.

This discrepancy often leaves business owners uncertain about their business’s true value and the price it might fetch in the market. Ultimately, your business’s actual value is determined by the price a willing buyer is ready to pay and what you, as the seller, are prepared to accept. All other valuation measures act as guides to help ensure both parties are within a reasonable market range.

Understanding Cash Flow as Seller’s Discretionary Earnings (SDE) or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
SDE and EBITDA provide insights into your business’s cash flow and are key indicators of profitability. The calculation starts with net operating profit, to which EBITDA and non-business-related expenses (such as personal expenses) are added back, along with one-time capital expenses, to arrive at SDE. Sometimes, buyers prefer using EBITDA without these add-backs, resulting in a different cash flow figure. This approach offers another perspective on your business’s financial health.

About the Industry Price Multiplier
Several data collection companies gather and analyze information on thousands of business sales nationwide, categorizing them by industry. The industry-specific multiplier is calculated by dividing the selling price by cash flow figures (SDE or EBITDA). This data analysis helps confirm trends and multipliers specific to each industry.
Even small changes in the multiplier can significantly impact your business’s valuation. For example, if your SDE is $1,000,000 and the multiplier is 2.2, your business valuation would be $2.2 million. If the multiplier increases to 3.2, the valuation jumps to $3.2 million—a $1 million difference with just a 1-point increase.
Even a 0.1-point increase can add $100,000 to your business’s value. Therefore, accurately determining the right multiplier is crucial as you set a market price for your business.

Industry Classification and Multiplier Impact
Industry-specific classifications, such as Standard Industry Classification (SIC) codes and North American Industry Classification System (NAICS) codes, also play an important role in evaluating your business’s value. Identifying the appropriate multiplier depends on how your business compares to others in the same industry. Ensuring precision in your base SDE calculation and selecting the correct multiplier are key. The size of your business relative to others in your industry category also influences the multiplier used.

In Conclusion
While there are multiple methods for valuing a business, the multiplier is a crucial element that will greatly influence its valuation. Businesses that can clearly demonstrate their ability to transfer value to a new owner (buyer) often achieve higher multipliers. As you prepare to sell your business, focus on proving this value to maximize your potential selling price.