Business value vs annual revenue

An owner asking what the business is worth may start from the one number they know well: what it takes in each year. That is a natural place to begin, but revenue and value are different kinds of figure. One is read off the financial statements. The other is a conclusion reached by a process. BDC notes that it is common for business owners to have a different value in mind than potential buyers, family successors, financial partners or tax assessors. This page sets the two side by side, using Canadian public sources.

What annual revenue is

The Business Development Bank of Canada (BDC) glossary describes net revenue as the total income a business earns from sales after subtracting returns, allowances and discounts. It is a reported figure. It tells you how much came in from customers over a period, and nothing in the definition says anything about what it cost to earn that income or what is left over. Two businesses with the same revenue can sit in very different positions once their costs, debts and owner pay are laid out. Revenue is also a record of the past, not a statement of what the business is worth to a new owner.

What business value is

BDC defines valuation as the process of determining the economic value of a business, and describes it as a process used to establish a company’s worth in dollars. BDC’s guide to what a company is worth describes earnings-based, market-based and asset-based methods, and says that under earnings-based methods a valuator determines the company’s value by reviewing forecasted earnings or cash flow and past results. So value is an output. CBV Institute’s glossary defines a standard of value as the definition of value used in a valuation, and defines fair market value in terms of a hypothetical willing and able buyer and seller, each acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and both have reasonable knowledge of relevant facts.

Where revenue does show up in a valuation

Revenue is not excluded from valuation. BDC explains that market approaches apply a valuation multiple, which may be based on EBITDA (earnings before interest, taxes, depreciation and amortization), revenue or other metrics. It adds that the figure and ratio used vary with the industry, the size of the company, market conditions and multiples used to buy or sell comparable businesses. BDC also states plainly that you cannot just apply a multiple. A revenue-based multiple is one tool inside a valuation, and a valuator still has to ask what sits behind the revenue. For how one earnings-based multiple works, see what an EBITDA multiple means.

What revenue leaves out

• Earnings and cash flow: BDC says that under earnings-based methods a valuator reviews forecasted earnings or cash flow and past results, which revenue alone does not show.
• Normalization: BDC lists failing to normalize earnings, by adjusting for discretionary and non-recurring items and non-market-rate revenues and expenses, as a valuation mistake.
• Direction of sales: BDC also lists ignoring changing sales trends, so one year’s revenue figure may not tell the story.
• Asset mix and outlook: BDC says the most suitable combination of methods depends on the purpose of the valuation and on the company’s profitability, future outlook and asset mix.

Which figure applies depends on…

These are factors to weigh, not a recommendation. If the figure is wanted for a sale, financing or another purpose, then BDC says the purpose shapes which combination of methods is most suitable. If earnings have not been normalized for discretionary and non-recurring items, then any number built on them may be off. If sales are rising or falling, then a single year of revenue may be a poor guide. If a multiple is involved, then BDC says the figure and ratio used vary with the industry, company size, market conditions and multiples used for comparable businesses. A qualified professional, such as a chartered business valuator or an accountant, can say which of these applies to a particular business.