What Is the Times-Revenue Method?
The times-revenue method is a valuation method used to determine the maximum value of a company. The times-revenue method uses a multiple of current revenues to determine the "ceiling" (or maximum value) for a particular business. Depending on the industry and the local business and economic environment, the multiple might be one to two times the actual revenues. However, in some industries, the multiple might be less than one.
- The times-revenue (or multiples of revenue) method is a valuation method used to determine the maximum value of a company.
- It's meant to generate a range of value for a business all based on the company's revenue.
- Times-revenue valuation will vary from one industry to the next due to the sector's growth potential; therefore, comparing different companies may be misleading.
- This method is not always a reliable indicator of the value of a firm as revenue does not mean profit and an increase in revenue does not always translate into an increase in profits.
- This method has the benefit of being easy to calculate, especially if the company already has a set of financial statements with reliable revenue totals.
Understanding the Times-Revenue Method
Small business owners might determine the value of the company to aid in financial planning or in preparation for selling the business. It can be challenging to calculate a business' value, especially if the value is largely determined by potential future revenues. Several models can be used to determine the value, or a range of values, to facilitate business decisions.
The times-revenue method is used to determine a range of values for a business. The figure is based on actual revenues over a certain period of time (for example, the previous fiscal year), and a multiplier provides a range that can be used as a starting point for negotiations. In effect, the times-revenue method attempts to value a business by valuing its stream of sales cash flows.
Depending on the period for which the revenue is considered or on the method of revenue measurement employed, the value of the multiple can vary. Some analysts use the revenue or sales recorded on proforma financial statements as actual sales or a forecast of what future sales will be. The multiplier used in business valuation depends on the industry.
Small business valuation often involves finding the absolute lowest price someone would pay for the business, known as the "floor," often the liquidation value of the business' assets, and then determining a ceiling that someone might pay, such as a multiple of current revenues. Once the floor and ceiling have been calculated, the business owner can determine the value, or what someone may be willing to pay to acquire the business. The value of the multiple used for evaluating the company’s value using the times-revenue method is influenced by a number of factors including the macroeconomic environment, industry conditions, etc.
The times-revenue method is also referred to as "multiples of revenue method."
The times-revenue method is ideal for younger companies with earnings that are either non-existent or very volatile. Also, companies that are poised to have a speedy growth stage, such as software-as-a-service firms, will base their valuations on the times-revenue method.
The multiple used might be higher if the company or industry is poised for growth and expansion. Since these companies are expected to have a high growth phase with a high percentage of recurring revenue and good margins, they would be valued in the three to four times-revenue range.
On the other hand, the multiplier used might be closer to one of the business is slow-growing or doesn't show much growth potential. A company with a low percentage of recurring revenue or consistent low forecasted revenue, such as a service company, may be valued at 0.5 times-revenue.
Criticism of the Times-Revenue Method
The times-revenue method is not always a reliable indicator of the value of a firm. This is because revenue does not mean profit. The times-revenue method fails to consider the expenses of a company or whether the company is producing positive net income.
Likewise, an increase in revenue does not necessarily translate into an increase in profits. A company may be experiencing 10% year-over-year growth in revenue, yet the company may be experiencing 25% year-over-year growth in expenses. Valuing a company only on its revenue stream fails to consider what it takes to generate its revenue.
To get a more accurate picture of the current real value of a company, earnings must be factored in. Thus, the multiples of earnings, or earnings multiplier, is preferred to the multiples of the revenue method.
The times-revenue method can be calculated forward or backward. You can divide the purchase price by annual revenue to arrive at the multiple, or you can multiple annual revenues by a desired times-revenue target to arrive at a potential target price.
Example of Times-Revenue Method
In fiscal year 2021, Twitter, Inc. reported annual revenue of $5.077 billion. Annual revenue for Twitter grew from 2020 to 2021 by over $1.3 billion. In 2022, Elon Musk announced his intention to acquire Twitter for $44 billion. This decision was later reversed and solidified via Securities and Exchange Commission filings.
Had the deal gone through, the acquisition would have occurred at company valuation of approximately 8.7 times-revenue. This means that at a theoretical acquisition price of $44 billion, Musk would have paid 8.7 times the annual revenue of Twitter (~$5.1 billion) as part of the deal.
Another interesting angle to this situation is Twitter's net annual loss. This demonstrates a glaring weakness of the times-revenue model. In 2021, Twitter incurred an annual loss of $221 million, it's second consider year of negative profit. Although the times-revenue valuation method indicates a value of 8.7, the method fails to consider that Twitter was not a profitable company at the time.
How Do You Calculate Times-Revenue?
Times-revenue is calculated by dividing the selling price of a company by the prior 12 months revenue of the company. The result indicates how many times of annual income a buyer was willing to pay for a company.
What Is a Good Times-Revenue Multiple?
Every company, industry, and sector will have different guidelines on what constitutes a good times-revenue valuation. Companies in higher growth industries will often sell for higher multiples due to the greater potential of future revenue. Alternatively, companies of different sizes may be valued differently due to the inherent risk of a newer business compared to an established company.
How Is the Times-Revenue Method Used?
Times-revenue is used to set a benchmark purchase price of a company. Using only the revenue of the business, a buyer can estimate a fair selling price by imputing what times-revenue they are willing to pay. Alternatively, a seller may have a purchase price in mind but must check times-revenue for reasonableness.
Is a Low Times Multiple Bad?
A low times multiple isn't necessarily bad. It simply means the company is being valued lower than other companies. If a seller is motivated to sell, having a low times multiple may be a good thing as it may be seen by buyers as a cheaper, potentially bargain price compared to companies with much higher multiples.