Some businesses have well established rules of thumb for value. Typically these would be businesses where most of the revenue is in the form of recurring revenue. A good example of this would be the alarm monitoring business. Alarm monitoring companies have customers that pay a monthly or annual fee to have their home or business monitored. The revenue tends to be pretty steady. Someone wanting to purchase such a business might use a rule of thumb such as paying 2 to 3 times annual recurring revenue adjusted for things like the amount and quality of other kinds of revenue,…

This method uses a multiple of "operating cash flow" or EBITDA to establish value. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Generally we use 3 to 5 years of historical operating results or for a cyclical business, one normal business cycle. The EBITDA is then adjusted for things like excess bonuses and unusual items to come up with a normalized EBITDA. We apply the multiple and then deduct the interest bearing debt to come up with the shareholder value. The multiple used will reflect the buyers assessment of risk – the lower the multiple the higher the perceived…

This is a more sophisticated valuation method and is preferred because it captures all the variables. Basically what we are doing is taking projected cash flows for a reasonable period (generally 3 to 5 years), discounting these back to the present value using a discount factor. We then determine a termination value for the cash flow beyond our forecast period, capitalize that and then discount this amount back to the present using the same discount factor. Adding the two together gives us the enterprise value. As in the Multiple of EBITDA Method, we then deduct the interest bearing debt to…