One of the most widely used valuation benchmarks, this method multiplies the sales or profits of a business by an industry averaged “multiplier” to calculate the value of the business.

This multiplier, which is based on average sales figures within the industry, is multiplied by either the company's profits or company's gross sales. For retail businesses, the companies gross sales and inventory are added together and then multiplied by the industry average figure.

When using the gross sales figure, the standard multiplier usually falls into the range of 0.25 to 1.0 or higher. When pretax profits are used instead of sales, multipliers may be 1, 2, 3, 4, with 5 being the typical ceiling. While the sales method is usually used as the main valuation benchmark, the pretax profit method can be used as the valuation ceiling benchmark.

You can get current industry multipliers from a number of sources, including trade associations, financial publications and brokers. Another good source, though a few years out of date, is "The Complete Guide to Buying a Business" by Richard Snowden (Amacom, 1994).

However, there are a couple of problems with this valuation method. First, this valuation method does not take into account important factors such as the profitability of the business and cashflow indicators for the company. Secondly, since this valuation is based on industry averages, it doesn't factor in the differences between companies within an industry, which can be very different in size, brand value, customer-base, management efficiency and other “soft” factors. These differences make it difficult to substantiate the validity of a multiplier, which can throw off the accuracy of the valuation.

Assessment & Valuation : Digging for Truth

Valuation Formulas: a) The Book & Adjusted Book Value b) The Liquidation Value