Most discussions about determining the value of a business, start — and frequently end — with an analysis of historical earnings and/or cash flow. Many buyers & quite a few brokers are most comfortable expressing their valuation as a multiple of last year’s earnings or cash flow, or as a multiple of the last three year’s average cash flow, or as a multiple of the trailing 12 months cash flow. One of the most commonly reported statistics regarding completed transactions is the multiple the purchase price represents when divided by last year’s earnings, or cash flow. And most banks seem to rely heavily on historical cash flow when deciding whether or not to finance a particular acquisition.
With all of this emphasis on history, it is tempting to conclude that the selling price of a business is DETERMINED by its historical earnings or cash flow.
From my experience, however, this is not really the case. What the buyer is ultimately buying is the EXPECTATION OF FUTURE CASH FLOWS. While an analysis of historical cash flows can shed light on the volatility or the likelihood of future cash flows, in the end it’s the expectation of future cash flows that determine the selling price.
So once again, if you looking for ways to improve the selling price of your business, work on improving its profitability and its cash flow.
If you know of a business owner who’s thinking of selling and who might benefit from a complimentary consultation with us, have them contact me, or any of the M&A professionals at www.bradwaygroup.com
By: Mike Ertel, Transworld M&A Advisors