The Logic behind the 3x Profit Company Valuation

Do you want to calculate your company value easily and uncomplicated?

First of all, it should be said that the rule of thumb that a company’s value is three times its profit is a myth that persists and is by no means a useful formula for every company. It is too undifferentiated and oversimplifies the reality of company valuation.

In principle, however, the multiplier method is a modern, sensible method based on industry comparisons. You can find a suitable multiplier for your industry and company size in the Nimbo market data.

How Does the 3x Profit Method Work?

This type of valuation is based on two main components:

• Choice of profit figure
• Choice of multiplier

Choose a Profit Figure

The selection of the correct profit figure (e.g. net profit, EBITDA or operating profit) is a crucial factor. Each of these figures has its own advantages and disadvantages. The industry, the business model and the financial structure are factors that can influence the selection of the profit figure.

Profit Figure Depending on the Industry

• Net profit is a common profit figure in many industries, especially in traditional and established companies. This includes industries such as retail, consumer goods, manufacturing and healthcare. Net profit takes into account all costs, including interest, taxes, depreciation and amortization, and provides a comprehensive insight into the company’s profitability.
• The EBITDA figure (EBITDA: Earnings before Interest, Taxes, Depreciation and Amortization) is often used in industries where high depreciation and amortization costs as well as high capital investments are common. This includes industries such as technology, telecommunications, private equity and real estate development. EBITDA is often preferred because it provides a better insight into the company’s operating profitability, regardless of financing costs and depreciation.
• Operating profit, also known as Earnings Before Interest and Taxes (EBIT), is used in many industries. It provides a clear picture of profits before financing costs (interest) are taken into account. Operating profit is valued in industries such as automotive manufacturing, aviation and hospitality.

Profit Figure Depending on the Business Model

• Cost structure: The business model determines how costs are incurred in a company. A company with a high proportion of operating costs compared to financing costs may opt for operating profit (EBIT) as a profit figure in order to assess pure operating profitability.
• Capital intensity: Companies that rely heavily on capital investments, such as manufacturers, opt for EBITDA because it shows profitability before depreciation and amortization and thus better takes into account the impact of investments.
• Start-ups and growth-oriented companies: Start-ups and companies in growth phases prefer EBITDA because they often make high investments and net profit may be distorted by high depreciation. EBITDA provides a better insight into operating profitability and growth potential.
• Taxes and legal aspects: The choice of profit figure can also be influenced by tax considerations and legal regulations. Some countries have specific tax regulations that influence the choice of profit figure.
• Investor preferences: If the company relies on investors, the choice of profit figure may depend on the preferences and expectations of potential investors. Some investors may prefer net profit, while others prefer EBITDA to better understand financial performance.
• Long-term vs. short-term view: Depending on whether the company is planning long-term or short-term, the profit figure may vary. Long-term investors may prefer net profit, while short-term investors may use EBITDA for a short-term profitability assessment.

Profit Figure Depending on the Financial Structure of the Company

The financial structure of a company refers to the way it is financed and what its capital structure looks like.

• Leverage: The leverage of a company, i.e. the ratio of debt to equity, can influence the choice of profit figure. Companies with high debt, where interest makes up a significant portion of the costs, should prefer EBITDA because it excludes interest and provides a better idea of operating profitability.
• Depreciation and amortization: for companies with significant depreciation and amortization costs, net profit is negatively affected. In such cases, EBITDA can also be used to assess profitability without these costs.
• Equity financing: Companies that are predominantly financed by equity should prefer net profit because they are not as dependent on interest payments and tax benefits for debt.

Make Adjustments

The profit must be adjusted for extraordinary or non-recurring events.

Choose a Multiplier

The multiplier is applied to the profit figure to calculate the company value. The following factors can lead to an upward or downward deviation.

Influence of the Industry

• Depending on the industry, there are different standards for valuation. It is important to compare the multiplier with the industry average.

Assess Risk Factors

• Risk assessment: Identify the specific risks to which your company is exposed. These can be economic risks, competitive risks, legal risks or operational risks.
• Determine risk level: Assess how high the risk is for your company on a scale from low to high. This can be subjective, but should be based on a thorough analysis.
• Adjustment of the multiplier: The higher the risk, the lower the multiplier should be. This means that your company will have a lower company value with higher risks.

Growth Potential

• Growth forecast: Estimate the future growth potential of your company. This can be based on historical growth rates, market analyses and strategic plans.
• Long-term and short-term consideration: Consider both long-term and short-term growth potential. Long-term growth can significantly increase the value, while short-term forecasts are relevant for current decisions.
• Adjustment of the multiplier: The higher the expected growth, the higher the multiplier can be. A company with strong growth potential will have a higher value.

Valuing a Company Using the Multiple Method

The Nimbo company valuation uses the multiple method and, in addition to figures such as turnover and profit, also takes into account various general and industry-specific value drivers. Free version available!