Business

The Pros and Cons of Revenue Multiples

Today, revenue multiples have become an important way of measuring the value of a company. Multiple revenues measure the equity of a company. The revenue multiples have become more popular that earnings and book value. In the past investor used the earning and book value to estimate the value of a company. However, due to limitations of the book value investors are now turning to the revenue multiples. The book value and earning was based, and it heavily favored companies with positive earnings and large companies. The revenue multiples are preferred because it can be used by troubled and young firms. The second problem with the book and earnings value is heavily relying on accounting practices.

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Accounting methods of depreciation and inventory valuation heavily impacted on the book value of a company. Thirdly, the revenue multiples is a stable approach. The earnings multiples is volatile hence it is less reliable compared to the multiples. Earnings are sensitive to economic changes hence they are volatile. For example, the price to earnings ratio is volatile compared to the price to sales ratio which is less sensitive to economic changes. The multiple revenues is widely used today hence it is important to look at the advantages and disadvantages of the multiple revenues.

Revenue Multiples
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The biggest advantage of the revenue is that it is less susceptible to accounting tricks. The revenue multiples does not rely on accounting information to estimate the value of a company. Accounting standards can create a loophole for business to manipulate accounting books and mislead investors. Some valuation methods rely on the accounting information. For instance, the book value of a business is determined by the method of stock valuation used, the depreciation method, and R& D. As a result, the book value is not a true reflection of the value of the company. The multiple revenues is a good valuation method for investors. It uses accounting information that is less susceptible to accounting tricks.

Being free of accounting trick makes the multiple revenues effective in comparing the value of a company to another company. The accounting standards can determine the book value of a business. As a result, it is not wise to compare the value of companies in different countries. The book value will have been estimated using different methods hence it less reliable. However, the revenue multiples allow investors to compare different companies. It applies similar valuation for all companies that is not influenced by accounting tricks.

The revenue multiple is available for all firms. It does not discriminate against small and young companies. Additionally, it does not favor companies that are performing well in the market, but it can be used by troubled companies. The multiple revenues can be used to estimate the value of small and young companies. Young companies have small sales and negative profits. Additionally, there is a lot of uncertainty that surrounds small companies. The companies may fail to make profits in the expected time. Investors who are willing to invest in small companies need to make a careful evaluation to eliminate some of the uncertainties. The revenue multiples provide investors with a good way of valuing small and troubled companies.

They can use nonfinancial factors to value the company. For instance, an investor can compare the enterprise value to company statistics such as the number of unique visitors on the company website and the number of new subscribers. The investor should then determine if the nonfinancial elements are being turned into sales. For instance, the investor can check the number of new subscribers to the company website and determine if this new number translated to a rise in sales and profits.

The multiple revenues benefit investors by being less volatile. The multiple revenues are less susceptible to change in the economy. The multiple revenues compared to book values are more stable and can be used to evaluate the value of most companies. A volatile metric valuation method such as the book earnings is more effective when a company is large and has stable cash flow and capital.
The multiple revenues have a number of flaws that impact on its effectiveness. It relies on the capital structure.

The enterprise value multiples are affected by the capital structure. The multiple revenues will be high for companies that are financed through equity. Companies financed through debt will have a low value. Companies can manipulate their capital structure and change debt to equity in order to record a high value.

Multiple revenues can also provide conflicting information. Different multiple revenues can lead an investor to make conflicting conclusions. For instance, if a company is measured using the enterprise value multiples it can give different results when the same company is valued using discounted P/E. An investor who uses a different multiple revenues may get different results from an investor who uses different methods. Additionally, different multiple revenues have a different conclusion based on the context.

Revenue Multiples - A Brief Conclusion

Therefore, multiple revenues is a difficult method of valuing stock of different companies. It is a subjective method that relies on the context and the type of method used hence it is hard to use it to compare companies unless they are subjected to similar conditions which are difficult.

Valuing the stock of a company is an interesting and important topic to investors. Investors must always ensure that they understand the methods used to value stock. They must know the basics of the methods used in order to know the right method to use when faced with different stock. For instance, the revenue multiple is a subjective method that is determined by various factors including the structure of capital.

An investor must be careful when using this method and consider the method used to finance the company. Additionally, when using it to compare different companies, investors must look at the context and the specific details of each company. However, the multiple revenues have certain advantages.

It is a simple method to use. Additionally, it is not influenced by accounting tricks and economic conditions. Understanding the advantages and disadvantages of the revenue multiples enlightens the investors, and they will be able to determine the situations in which this method is appropriate.