How to Calculate Company Valuation Based on Turnover

Conducting a company valuation based on turnover or revenue is one of the quickest and easiest methods. 

However, the math could quickly go wrong if you don't know how to determine or apply the correct revenue multiple.

In today's discussion, we explore the two key methods for calculating your company's value based on its turnover, the limitations to consider, and why it's crucial to work with M&A experts. 

TL;DR - How to Calculate Company Valuation Based on Turnover

Here are the steps to determine company value based on turnover:

1. Determine your company's annual revenue 

2. Identify comparable companies 

3. Determine the revenue multiples of the companies 

4. Apply the derived revenue multiple to your company

As you'll notice, determining the valuation of a company based on revenue or turnover is quite straightforward once you have the revenue multiple.

However, identifying the right comparable companies and accessing and assessing their financial data can be difficult.

When you work with Exitwise, we help you find and work with the best M&A experts in your industry to determine the value of your business based on various methods, including your turnover. 

These industry-specific M&A experts can help you select the right comparable companies and assess them to determine the correct revenue multiple to apply to your company. 

Consult with us at Exitwise to hire the right experts for an accurate valuation and optimal exit. 

When to Use Turnover as a Valuation Metric

You can use turnover or revenue as a business valuation metric in the following scenarios:

• When your company has stable and predictable revenues but isn't profitable or highly profitable yet

• If your company is young and has a high potential for growth but currently has little to no earnings

• If your company is expected to have a speedy growth stage coupled with high recurring revenues

• When you require a quick high-level valuation estimate to use it as a starting point or benchmark with other comprehensive business valuation methods

Limitations of Turnover-based Valuation

While quick and convenient, determining business valuation based on turnover has various limitations that could affect accuracy and objectivity. 

Let’s look at the major ones:

• Ignoring Profitability: Since the valuation is based primarily on revenue, it overlooks profitability, a key determinant of a business's value. A business with lower revenues but high profitability (due to lower operating costs) would be more valuable than one with high revenues but zero profits. 

• Ignoring Operating Costs and the Cost of Goods Sold: The valuation of a business based on revenue overlooks the cost of goods sold and the operating costs associated with generating the indicated revenue. As such, you overlook the free cash flows available for more comprehensive valuations. 

• Overlooking Dependency Risks: The method ignores dependency risks by assuming that the revenue is distributed across different streams or customers. In truth, the business’s sustainability may be compromised if the revenues come from a single or a few large customers or contracts. 

• Overlooking Seasonality: With the turnover model, businesses with frequent seasonality cycles may have low valuations in low seasons, even if their high seasons can compensate for the slower months. You'll want to determine how much you can sell your business for during a high season. 

• Overlooking Intangible Assets: The revenue valuation method ignores intangible assets like customer and vendor relationships, intellectual property, and brand reputation. Including the value of such assets can significantly increase the overall value of your business. 

Industry Benchmarks for Revenue Multiples

Since obtaining the financial data of comparable companies can be challenging, knowing the average revenue multiples for businesses in your industry can be a game changer. 

Below are some industry-specific revenue multiples based on data from the New York University Stern School of Business:

Note: Revenue multiples vary depending on factors such as prevailing local and global market conditions, regulatory environment, supply chain resilience, market share, and diversity in revenue streams. 

Key Methods for Company Valuation Based on Turnover

There are two key methods for calculating company valuation based on turnover:

1. Revenue Multiple Method

The revenue multiple method is also called the ‘times revenue method’ or ‘multiple of revenue method.’

To calculate valuation as a multiple of revenue, you need your company's annual revenue and a revenue multiple derived from comparing the values and revenues of peer companies. 

2. Capitalization of Revenue

If you can't access the financial data of your peer companies, you can use a capitalization rate instead to determine your company's valuation based on turnover. 

The capitalization rate, or cap rate, converts expected future revenue into present values and reflects the company's risk profile and prevailing market conditions. 

Unlike the ‘times revenue method,’ the capitalization method uses the net operating income or revenue from sales, which is the total revenue minus the operating expenses. 

Net Operating Revenue = Total Annual Sales Revenue - Total Annual Operating Expenses

How to Calculate Company Value Based on Turnover

Now that we know the two valuation methods, let's discuss how to determine the value of your company using its turnover in greater detail:

1. Determine Your Annual Revenue 

Begin by calculating the annual turnover or revenue for your company. If possible, you can use the revenues of the last 3-5 years and calculate the average annual revenue. 

• Revenue can come from selling services or products, referred to as sales revenue or operating revenue from primary business operations. 

• You could also have revenue from non-primary business operations, which is non-operating revenue. Such sources may include income from dividends, interest, property rent or leases, and selling capital and assets. 

For this article, we'll use annual revenue to refer to the income your company generates in a 12-month period from selling products or services. 

Most small and medium-sized businesses typically rely on operating revenue as they rarely have any income from non-primary business activities. 

To obtain your company's annual revenue, multiply the number of each service or product sold that year by the unit sale price. 

Alternatively, you can obtain the number from the company's income statement. The statement shows annual revenue, usually including sales and non-operating revenue. 

If you don't have any non-operating revenue, the annual revenue will reflect the annual sales revenue. 

2. Identify Comparable Companies 

Select the right peer companies in your sector to compare with yours. These should be comparable to yours in size, revenue, operations, and risk profile, among other aspects. 

A good idea here is to start with direct competitors. 

3. Determine the Revenue Multiples of the Companies 

Once you have selected the comparable companies and obtained their financial data, calculate the revenue multiple for each company. 

Here's the formula to use:

Revenue Multiple = Company Value ÷ Annual Revenue

For example, if a similar trucking company is valued at $550,000, and its annual revenue is $297,297, its revenue multiple is:

Revenue Multiple = $550,000 ÷ $297,297 = 1.85x

If there are multiple competitors, repeat the process to obtain the business valuation revenue multiple for each company. 

Finally, determine the average revenue multiple by adding all the revenue multiples obtained and dividing the sum by the number of companies considered. 

4. Apply the Derived Revenue Multiple to Your Company

You can now apply the derived average revenue multiple to your annual revenue using the formula:

Business Value = Annual Revenue x Revenue Multiple

If you use the average revenue from several years, adjust the formula accordingly:

Business Value = Average Annual Revenue x Revenue Multiple

Let's have a quick example. We'll assume you are valuing an assets management company with an annual revenue of $128,000. You'll apply the market-derived revenue multiple in the table above for the asset management sector.

Business Value = $128,000 x 6.01 = $769,280

Let's have another quick example, this time assuming you are valuing a hotel business with a projected annual net operating revenue of $900,000 and a market-derived cap rate of 9.0%.

Business Value = Projected Annual Net Operating Revenue ÷ Cap Rate

Business Value = $900,000 ÷ 9% = $10,000,000

These calculations can be time-consuming. Before you bring in M&A experts to help you, you can use our free Exitwise business valuation calculator to estimate your company’s value. 

Frequently Asked Questions (FAQs) 

Here are some questions business sellers usually ask about valuing a company based on turnover or revenue:

What is the Most Accurate Way to Perform Company Valuation Based on Turnover?

Using a revenue multiple is the most accurate method to calculate a company’s valuation based on turnover. 

Applying the multiple yields more dependable results than using the capitalization method. The latter is susceptible to cap rate fluctuations; even the slightest changes can significantly sway the value. 

What Industries Commonly Use Business Valuation Revenue Multiple?

The revenue multiple valuation method is typically used for businesses with high growth potential but low or zero profits in industries such as:

• Hotels and restaurants 

• Retail (especially consumer goods)

• Technology (tech startups, including SaaS companies)

• E-commerce (online retailers and marketplace sellers)

• Professional services (agencies and consulting firms)

• Financial services (fintech companies and insurance firms)

• Entertainment and media (streaming services and content providers)

• Telecommunications (internet providers and mobile service companies)

• Healthcare and biotechnology (healthcare services and early-stage health tech startups)

How Reliable Is the Times Revenue Method for Startups?

The ‘times revenue method’ is adequately reliable, provided you select the right peer companies. These should have qualities such as:

• They typically have high recurring revenues, even if they are not profitable or highly profitable yet.

• Their main focus is growth in their early stages.

What Are the Common Mistakes in Revenue-Based Valuation?

You'll want to avoid the following common mistakes when using the revenue-based valuation method:

• Using an inappropriate capitalization rate or the revenue multiple for your industry.

• Not including all your sales revenue streams.

• Selecting peer companies that do not accurately compare to yours in size, growth potential, revenue, operations, and profitability.

• Conducting the entire business valuation on your own (which can skew the value due to subjectivity).

Conclusion

In this guide, we've explored the two key methods you can apply in a revenue-based valuation, the limitations to consider, and the ideal situations when to use this type of valuation.

While conducting a company valuation based on turnover is relatively fast and easy, certain aspects, such as choosing the right peer companies, can be tricky. 

At Exitwise, we believe the best decision you can make when valuing and selling your company is to hire M&A experts to help you. 

That’s why we help you find, recruit, and work with the best M&A experts who specialize in your industry. We can connect you with investment bankers, financial accountants, and wealth advisors to help optimize your exit strategy. 

Reach out to our team today to find the best M&A experts for an accurate business valuation and faster exit.