Multiple of Discretionary Earnings

Business valuation inputs

This valuation method uses a single-point economic benefit input, such as the seller’s discretionary cash flow, and a number of business valuation criteria to perform the valuation.

The first step in using the Multiple of Discretionary Earnings business valuation method is to determine the appropriate SDCF value. This value should best represent the expected future earnings. Typical ways of estimating the SDCF value used in this valuation method include:

  • Average historic SDCF derived from your recast business financials.
  • Weighted average historic SDCF.
  • Squared weighted average historic SDCF.
  • Custom weighted SDCF calculation, that best reflects the likely future business earnings.

Examples:

  • Year 1: $100,000
  • Year 2: $120,000
  • Year 3: $130,000 (most recent year).

The simple average:

SDCF = ($100,000 + $120,000 + $130,000) ÷ 3 = $116,666.67

The weighted average:

SDCF = ($100,000×1 + $120,000×2 + $130,000×3) ÷ 6 = $121,666.67

The squared weighted average:

SDCF = ($100,000×1 + $120,000×2² + $130,000×3²) ÷ 14 = $125,000.00

You can also use a set of custom averaging weights, depending upon which history cash flow values are more representative of the expected future business performance. For example, there may be an especially good or bad year that is not likely to reoccur. In this case, the weight applied to that year’s SDCF may be equal to zero.

Next, you will need to identify the remaining valuation inputs:

Determine the value of each multiplier to use. ValuAdder Learning and Information Center has a table that explains how to choose each multiplier. Generally, better historic business performance and positive future outlook result in higher multiplier values.

Determine the net working capital from your adjusted financial statements. For the purposes of business valuation, the net working capital is the difference between the normalized current assets (excluding inventory) and current liabilities (excluding the short term portion of long term debt).

Determine the non-operating asset value from the adjusted financial statements. Input the value only if the non-operating assets are transferred to the buyer as part of the business purchase.

Subtract the long-term liabilities, if these are to be assumed by the buyer as part of the business purchase.