What Is the Times-Revenue Method?

What Is the Times-Revenue Method?

Let me explain the times-revenue method directly: it evaluates a company's worth by applying a multiple to its revenue over a specific period. This gives you a straightforward way to estimate business value, but remember, it doesn't factor in expenses or profitability. You'll often see it used for young firms with volatile earnings or in high-growth sectors.

The multiple you apply varies by industry and other factors, but it's typically one or two. In some cases, especially in slower industries, the multiple might even be less than one.

How the Times-Revenue Method Works

You might need to determine a business's value for reasons like financial planning or preparing to sell it. Calculating that value can be challenging, especially when it's based on potential future revenues. There are several models to help you find a value or a range of values to guide your decisions.

The times-revenue method tries to value a business by focusing on its cash flow. It determines a range of values based on actual revenues over a period, like the previous fiscal year. Then, a multiplier gives you a starting point for negotiations.

That multiplier depends on the industry. For small businesses, valuation often starts with the absolute lowest price—the 'floor,' which is usually the liquidation value of assets. Then you set a ceiling, the maximum a buyer might pay, like a multiple of current revenues.

Once you have the floor and ceiling, you can figure out the value someone might pay to acquire the business. Factors like the macroeconomic environment and industry conditions influence the multiple in this method.

Important note: the times-revenue method is also called the multiples of revenue method.

Ideal Candidates for the Times-Revenue Method

This method works best for young companies with volatile or non-existent earnings. If you're dealing with firms poised for speedy growth, like software-as-a-service companies, they'll often use times-revenue for valuations.

You might apply a higher multiple if the company or industry is set for growth and expansion. Companies with high recurring revenue and good margins could be valued at three to four times revenue.

On the other hand, if the business is slow-growing or lacks potential, the multiplier might be one. A service company with low recurring revenue or consistently low forecasts might be valued at 0.5 times revenue.

Limitations of the Times-Revenue Method

Be aware that the times-revenue method isn't always reliable for indicating a firm's true value. Revenue doesn't equal profit, and this approach ignores expenses and whether the company generates net income.

An increase in revenue doesn't always mean more profits—revenue might grow 10% yearly, but expenses could rise 25%. Valuing based only on revenue misses the costs to generate it.

For a more accurate picture of a company's current value, you need to factor in earnings. That's why the multiples of earnings method is often preferred over multiples of revenue.

Fast Fact

You can calculate the times-revenue method forward or backward: divide the purchase price by annual revenue to get the multiple, or multiply annual revenues by a target multiple to find a potential price.

Applying the Times-Revenue Method: A Case Study

Take X (formerly Twitter) in fiscal year 2021: it reported $5.077 billion in revenue, up over $1.3 billion from 2020. In 2022, Elon Musk intended to buy it for $44 billion, a deal that went through after some back-and-forth.

That acquisition valued the company at about 8.7 times revenue—$44 billion divided by $5.1 billion. But here's the weakness: the company had a $221 million net loss in 2021, its second year of negative profits. The method doesn't account for that lack of profitability.

Post-acquisition, X's 2022 revenue dropped 11% to $4.4 billion, with an estimated $152 million loss, partly from cost-cutting and loan costs. By April 2023, it merged into X Corp., owned by Musk.

How Do You Calculate Times-Revenue?

You calculate it by dividing the selling price by the prior 12 months' revenue. The result shows how many times annual income a buyer paid.

What Is a Good Times-Revenue Multiple?

It varies by company, industry, and sector. Higher-growth industries often have higher multiples due to future revenue potential. Newer businesses might have different valuations due to higher risks compared to established ones.

How Is the Times-Revenue Method Used?

You use it to set a benchmark purchase price. A buyer estimates a fair price by deciding what multiple of revenue they're willing to pay. A seller might have a price in mind but checks it against times-revenue for reasonableness.

Is a Low Times Multiple Bad?

Not necessarily—a low multiple just means a lower valuation. If you're motivated to sell, it could attract buyers looking for a bargain compared to higher-multiple companies.

The Bottom Line

The times-revenue method gives you a simple way to value a company by multiplying revenue over a period by an industry factor. But it has big limitations: it ignores expenses and profitability, so revenue isn't a full indicator of value.

Like all methods, it uses historical data and can't predict the future. For a complete valuation, consider earnings and other metrics alongside revenue.