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Beware the Enterprise Valuation Measure

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White Paper

Fisher International

Determining the value of a business requires an in-depth analysis of the current and future financial state of the company along with a solid understanding of its markets and the specific environment in which it operates. As a Certified Valuation Analyst®, I was trained to measure the value of a firm based in three key areas:

  • Cash flow generated by the business
  • Growth of that cash flow
  • Risk associated with the cash flow

A valid valuation of any business requires math…and math is hard. Perhaps because math is hard, but probably more likely because a true business valuation takes time, many managers, owners and analysts fall into the trap of using a “multiple” approach to valuation. The value of any business, the multiple approach says, can be easily and quickly calculated by picking some financial measure – like revenue or gross profit – and multiplying it by some common factor.

For example, insurance agencies have for years been valued at two times the annual premium revenue. Really? Does every insurance agency have the same expenses associated with producing premiums? What about growth? Does every agency grow at the same rate? Of course not. But the multiple approach assumes all things are equal. This makes it easy to use but it also makes it completely wrong.

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