Business Valuations Based on Net Profit

Business valuations based on net profit take the net profit of your business and multiply it by the industry multiplier of your company’s industry to see an estimated value of your company. These estimated valuations help you better understand your company and its chance of growth and can be useful figures to share with stakeholders, investors, and potential buyers as they will learn more about the business’s profitability and effectiveness. It does not show investors the business’s potential or performance, but it is a good way to value a business, especially when used in conjunction with other valuation tools.

What is net profit?

Net profit is the money a business makes after its expenses, taxes, and other costs relating to its operations. Business owners, stakeholders, and investors should all be aware of net profit to help them understand the company and how it can make earnings and expand over time.

Calculating the net profit is easy, as you take a business’s total revenue from a certain period (month, quarter, year) and deduct all expenses from the same period. Your expenses might include:

• Cost of goods sold
• Interest expenses
• Operating expenses
• Taxes

Can you use net profit to value a company?

Yes, net profit is frequently used to value a company and is one financial measurement used when calculating a company’s total worth. A company’s net profit shows you its profitability and effectiveness, which are important aspects in evaluating its market value. However, we do not recommend depending solely on net profit when valuing a business, as it can be misleading. Net profit does not cover every part of a business performance or p[potential, and you should also consider the following factors:

• Cash flow
• Debt to equity ratio
• Gross profit margin
• Market conditions and industry trends
• Operating profit margin
• Price-to-earnings ratio
• Revenue

How to use net profit for business valuations

Using net profit to value a business is a popular approach, looking at the average annual net income of the business and an industry-specific multiplier to provide you with a reliable valuation. We have outlined the steps you can follow to value a company using net profit below:

Step 1 – Calculate the average annual net income

To start, you need to work out the average net profit your company has earned. You will want a period longer than the last year for a more accurate estimate. Five years is recommended, as it will give you a reliable figure that accounts for any fluctuations in the company’s performance.

Step 2 -Determine the industry multiplier

Next, you need to determine the industry multiplier, a standard number used to value companies in your sector. The multiplier varies across industries and is usually determined by consensus, reflecting common business practices and market conditions.

The industry multiplier can vary every year depending on industry trends and economic factors. You will need to check industry reports and trade associations for your industry multiplier. A business valuer will also assist you here, providing the multiplier and guidance when determining the value of your business.

Step 3 – Apply the profit multiple valuation method

To use net profit to value a business, you will need to use the profit multiple valuation method. You will multiply the average net income of your business by the industry multiplier, giving you an estimated company valuation.

The profit multiple valuation method allows you to have a comprehensive and accurate valuation of your company based on industry standards and your business’s net profit. It helps you with strategies, decision-making, assessing investment opportunities, or attracting potential buyers.

It is worth remembering that this is just one method to calculate the value of a business, and you should consider other options to understand a business’s worth, like holistic analysis.

What are the benefits of using net profit for business valuations?

Using net profit to value businesses does come with many benefits, including its complete asset assessment, profitability, and more. To help you see if it’s the valuation method for you, we have detailed its three largest benefits below:

Complete asset assessment

Net profit looks at your tangible assets (like equipment and property) and your intangible assets (like patents and trademarks), providing a comprehensive view of a company’s value. The complete asset assessment helps stakeholders to make smarter investment choices.

Validation of financial statements

Analysing net profit alongside cash flow statements, balance sheets, and income statements ensures the business valuation is based on consistent and reliable data. Doing so enhances the credibility of the company’s financial information, making it a more enticing sale or investment opportunity.

Profitability and efficiency

Net profit also highlights a company’s ability to generate earnings, showing its operational efficiency and profitability. These features are crucial for assessing a company’s long-term success and growth potential.

What are the drawbacks of using net profit for business valuations?

Net profit can provide fantastic insights into your company’s financial health, but there are some drawbacks that you should consider. We have outlined the three main drawbacks below:

Insensitive to industry and market conditions

Net profit does not consider the account industry-specific factors and market conditions that could impact your business valuation. A more comprehensive business valuation will consider these external factors, accurately assessing a company’s worth within its market and industry.

Overlooks non-cash items and cash flow

Net profit also does not consider non-cash items like amortisation and depreciation, which affect a business’s cash flow. Cash flow is vital for meeting financial responsibilities and investing in growth, so by ignoring these, you might not get an accurate picture of the company’s financial well-being.

Susceptible to accounting manipulation

Several accounting policies and practices can influence net profit, which can distort the true financial performance of a company. You might get an inaccurate valuation based on inconsistent or manipulated financial data.

Get in touch with a business valuation expert near you

Business valuations based on net profit are insightful but do not always show the whole picture of your business. A business broker might request a business valuation based on net profit, and we can ensure that you have everything you need. We will offer a valuation based on net profit and look at the current market value of similar businesses and other valuation methods to provide an accurate valuation that helps you sell your business.

We have business valuation experts across Australia, and you can get in touch with them by following the details below:

• Get in touch with our business valuation experts in Brisbane
• Get in touch with our business valuation experts in Sydney
• Get in touch with our business valuation experts in Melbourne
• Get in touch with our business valuation experts in Perth
• Get in touch with our business valuation experts in Adelaide
• Get in touch with our business valuation experts on the Gold Coast
• Get in touch with our business valuation experts on the Sunshine Coast