The logic behind the 3x profit company valuation

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

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

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

How does the 3x profit method work?

This type of assessment is based on two main components:

• Choice of profit ratio
• Choice of multiplier

Choose a profit ratio

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

Profit ratio depends on the industry

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

Profit ratio depends 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 choose to use operating profit (EBIT) as a profit metric to evaluate pure operating profitability.
• Capital intensity: Companies that rely heavily on capital investments, such as manufacturers, choose 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 large investments and net profit may be distorted by high depreciation. EBITDA provides better insight into operating profitability and growth potential.
• Tax and legal aspects: The choice of profit ratio can also be influenced by tax considerations and legal regulations. Some countries have specific tax regulations that influence the choice of profit ratio.
• Investor preferences: If the company relies on investors, the choice of earnings ratio may depend on the preferences and expectations of potential investors. Some investors may prefer net income while others may prefer EBITDA to better understand financial performance.
• Long-term vs. Short-term view: Depending on whether the company is planning for the long term or the short term, the profit ratio can vary. Long-term investors might prefer net income, while short-term investors might use EBITDA for a short-term profitability assessment.

Profit ratio depends 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 is.

• Debt ratio: The debt ratio of a company, i.e. the ratio of debt to equity, can influence the choice of profit ratio. Companies with high levels of debt where interest represents a significant portion of costs should prefer EBITDA because it excludes interest and provides a better idea of operating profitability.
• Depreciation and amortization: companies with significant depreciation and amortization costs will have a negative impact on net profit. 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 on debt.

Make cleanups

Profit must be adjusted for extraordinary or non-recurring events.

Choose a multiplier

The multiplier is applied to the earnings ratio to calculate the company value. The following factors may cause a deviation upwards or downwards.

Impact of the industry

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

Assess risk factors

• Risk assessment: Identify the specific risks your business faces. These can be economic risks, competitive risks, legal risks or operational risks.
• Set risk level: Rate the risk to your business on a scale from low to high. This may be subjective, but should be based on thorough analysis.
• Adjusting the multiplier: The higher the risk, the lower the multiplier should be. This means that if the risks are higher, your company will have a lower enterprise value.

Growth potential

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

Evaluating a company using the multiple method

The Nimbo company valuation uses the multiple method and takes into account not only figures such as sales and profits but also various general and industry-specific value drivers. Free version available!