List of Valuation Metrics - 7 Key Indicators to Track

Whether you want to improve your investment strategy, financial plans, or exit strategy, you must consider the right valuation metrics for the correct valuation and even the best sale price.

However, calculating your business's worth can be overwhelming. You must choose the correct metrics, and the fact that there are so many makes it more challenging to decide. You don't have to struggle anymore. 

This guide explores the most important valuation metrics to help you improve your business and exit strategy. We'll also discuss how these metrics influence investment decisions and common mistakes you must avoid when using them. 

TL; DR - List of Valuation Metrics

Here are seven key valuation metrics you can use when determining the value of your business for internal purposes or before a sale:

1. Price-to-Earnings Ratio

2. Revenue

3. Discounted Cash Flow

4. Enterprise Value 

5. EBITDA

6. Seller's Discretionary Earnings

7. Debt-to-Equity Ratio

We’ll discuss each metric in detail later in the article. As you'll notice, choosing and working on these metrics can be challenging without the help of M&A experts.

At Exitwise, we help you review, hire, and manage the best industry-specific M&A experts, such as M&A attorneys, investment bankers, and finance accountants.

If you’re looking for an exit, these experts can help you value your company and quickly sell it at the highest possible price. Chat with us at Exitwise today to maximize your exit.

What Are Business Valuation Metrics?

Business valuation metrics are financial indicators that potential buyers or investors use to assess the worth of a business. While they are also called business ratios or valuation ratios, some aren't ratios. 

Valuation metrics are part of the larger group of financial statement metrics because they usually derive from financials such as balance sheets and income statements.

How Do Valuation Metrics Drive Investment Decisions?

Generally, valuation metrics influence investment decisions by helping potential investors understand a company's current price versus its prevailing financial performance.

With this information, investors can assess whether the company is worth investing in or if it will offer the best value for their money based on its growth potential and financial health.

Here are some major ways these metrics can affect investment decisions:

Comparing Target Companies within an Industry

Valuation metrics allow investors to compare companies within the same industry or sector to see which one is performing better and has a favorable sale price relative to its financial health.

Even if they have different operating models and revenue ranges, investors will typically opt to buy the company with a favorable sale price and better financial performance.

Assessing Risk

Investors can use valuation indicators to assess a business's financial muscle and potential risks to its capital structure. 

A lower risk level will attract buyers willing to pay more for your company.

Diversifying Investor’s Portfolio

Investors use valuation analysis to inform their diversification strategy, which involves spreading their investment portfolio across different sectors, locations, and asset classes.

Potential business acquirers consider valuation metrics such as revenue, enterprise value, and EBITDA to determine whether your business’s financial health aligns with their investment strategy.

If your company favors their strategy, investors are more likely to buy your business at a higher price.

Improving Business Value

As a business owner or CEO, you can use valuation metrics internally to maximize business value. Different metrics can show your business's strengths and weaknesses, allowing you to decide which strengths to build on first and the shortcomings to prioritize.

Improving the value of your business over time can help you attract potential buyers. You can also receive the best sale price when you finally sell your business.

List of 7 Key Valuation Metrics to Track

Let’s discuss the seven critical metrics you need to measure in your business:

1. Price-to-Earnings Ratio

The P/E, or price-to-earnings ratio, compares a company's stock's market value to its annual earnings per share (EPS).

P/E ratio = Stock value ÷ Earnings per share

If the P/E ratio is high, investors may consider your stock’s price overvalued.

Investors typically prefer companies with low P/E ratios, which indicates the stock could be undervalued. The idea is to seize the opportunity for long-term gains when the stock's value and price increase.

2. Revenue

The total amount of money your company brings in after selling its services or products is a good measure of your potential for growth, clearing debts, profitability, and sustainability.

Buyers want to see a company with high revenues and a fair balance between them and profitability. If you spend too much on operating expenses and reduce what's leftover from revenue, your company will likely command a lower valuation.

3. Discounted Cash Flow

The discounted cash flow (DCF) valuation method estimates the value of a company using its projected future cash flows using the formula below:

Company Value = Total Discounted Cash Flows = CF₁ ÷ (1 + r)¹ + CF₂ ÷ (1 + r)² + … + CFₙ ÷ (1 + r)ⁿ 

Where: 

CF₁ and CF₂ = Cash flow for years 1, 2, and so on

CFₙ = Cash flow for the nth year

n = The forecast period number (number of years)

r = Discount rate

Here’s why the DCF matters:

• The cash flows become a key valuation metric when you discount them to their present value to account for the time value of money.

You use a discount rate, usually, the Weighted Average Cost of Capital (WACC), to account for the risk associated with the cash flows.

• Besides adjusting for risk and the time value of money, most business buyers prefer the discounted cash flow metric because cash flows are not as easy to manipulate as earnings.

• The metric is also highly customizable to capture the growth potential and unique characteristics of a target company. 

For example, you can adjust the projected cash flows and discount rates to reflect varying risk levels and scenarios. Use the highest possible, normal, and lowest possible cash flow values to show best-case, base-case, and worst-case scenarios. You can also use a high discount rate to reflect a riskier investment or a lower rate to reflect a less risky one. 

4. Enterprise Value 

Investors use the enterprise value to determine the possible price they can pay for your company based on its capital structure (equity and debt).

How Is the Enterprise Value (EV) of a Company Calculated?

You can calculate your enterprise value using the formula below:

Enterprise Value = Market capitalization + Total debt - (Cash and Cash equivalents)

Where;

• Market capitalization is the total worth of the company's publicly traded shares (number of outstanding shares multiplied by the price per share).

• Total debt includes both long-term and short-term debt.

• Cash and cash equivalents are the most liquid assets, like cash on hand.

You can use the enterprise value metric if you are looking to exit through a stock sale.

5. EBITDA

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, as shown in the formula below:

EBITDA= Net Income + Interest + Taxes + Depreciation + Amortization

The EBITDA metric shows how profitable a company is before you consider non-operating costs like interest and taxes and non-cash expenditures such as amortization and depreciation.

If your company has a high EBITDA, it can generate high earnings and profits from its core operations. Potential buyers are usually willing to pay more for companies with high EBITDA.

You can use our free online valuation calculator to see how many times your business is worth its EBITDA.

6. Seller's Discretionary Earnings 

The SDE is the total annual financial benefit you get from your business as the owner, as per the formula below:

SDE = Earnings Before Taxes (EBT) + Owner’s Salary + Net Interest Expense + Depreciation and Amortization (D&A) + Discretionary Expenses + Non-Recurring Expenses (such as personal expenses)

The metric is important for several reasons:

• You and your potential buyers can see if you have been paying yourself a salary that fits the prevailing market rates. If not, the metric helps adjust your compensation to match your business's income more realistically.

• You can compare your business's performance to that of similar small businesses to see the SDE multiple to apply when valuing it.

• Potential buyers can better assess your business's profitability when you factor in expenses that aren’t related to your mainstream business operations.

7. Debt-to-Equity Ratio

The D/E ratio or debt-to-equity ratio determines the amount of a company's funding derived from debt relative to equity:

Debt-to-Equity Ratio = Total Debt / Shareholders’ Equity

If the ratio is high, most company operations are funded through creditors instead of investors, indicating high financial risk. For most industries, the ideal ratio is less than 1 but not more than 2. 

When selling your company, you'll want to reduce debt to manageable levels. Investors look for companies with lower debt-to-equity ratios because they can pay their equity holders better.

Common Mistakes to Avoid When Using Valuation Metrics

Since valuation metrics rely on other financial aspects like incomes, profits, and taxes, it can be easy to make costly mistakes. 

Here are some you'll want to avoid:

• Using Inaccurate or Outdated Data: It's unethical to use incorrect data, such as inflated EBITDA, to make a company's financial health look better than it really is. If potential buyers notice the use of incorrect or outdated data, they can easily withdraw from a potential M&A deal.

• Using Only One Metric: No valuation metric is perfect because they all use historical data and don't always capture the prevailing market conditions or a company's growth potential.

• Using Similar Metrics for Different Sectors: You should avoid comparing your company's metrics with those of another unrelated sector. Different sectors have different capital requirements, so comparing your company's metrics with those outside your industry is unfair.

• Neglecting Qualitative Factors: Leaving out qualitative factors can make your company look less attractive to investors. Include impact metrics like carbon emissions and job creation to measure your company’s environmental and social influence. A positive impact can increase your company's sellability score.

Exitwise Helps You Hire the Best M&A Experts

Choosing the right valuation metrics and calculating your company valuation correctly can be overwhelming when you do it alone. You'll need the help of qualified M&A professionals to increase your chances of selling faster and at the best price possible.

At Exitwise, we help you find and manage the best M&A experts in your industry using three key steps:

• First, we consult with you to learn more about your business and objectives. We'll also answer your questions about the M&A process.

• Secondly, we will explore which top M&A professionals can best serve your business before we connect you to chat with them. We'll also help you interview and hire different experts.

• Lastly, we'll help you negotiate the best fees and terms and manage the experts. We'll also advise you throughout the M&A process.

We are dedicated to helping you sell your business sooner at the highest price possible. We can help you hire M&A advisors, wealth advisors, investment bankers, and accountants to increase the chances of a high-value sale.

Reach out to us today to learn more about how we can help you achieve the exit of your dreams.

Frequently Asked Questions (FAQs)

Here are answers to frequently asked questions about the topic:

What Is the Difference Between Enterprise Value and Market Value?

Enterprise value is a company's total value based on its market capitalization, debt, and cash.

On the other hand, market value is the total value of a company's outstanding stock market shares.

Enterprise value is more inclusive because it captures a company's market capitalization, which is also its market value.

How Are Growth Companies Valued Differently from Value Companies?

The discounted cash flow (DCF) formula and price-to-earnings (P/E) ratio can be used to evaluate both growth and value companies.

The terminal value is usually high for a growth company, accounting for 80% to even over 100% of the company's total value. The P/E ratio is also significantly high for these companies.

To reduce the implication that a growth company is too expensive, the price-to-earnings ratio is usually adjusted using the expected growth rate:

PEG ratio = P/E ratio ÷ Expected growth rate

Conclusion

We've looked at the key valuation metrics potential buyers and investors consider to see if your company is worth buying.

While they can be difficult to work with, these metrics can help you discover where to improve your company to fetch a higher sale price.

You don't have to do it alone. We at Exitwise can help you find the best M&A team of wealth advisors, finance accountants, and investment bankers to work with you.

These experts help you value your business and sell it fast at a favorable sale price. Consult with us at Exitwise to find your dream M&A team.