Tips for Using Multiples

Ensure Cash Flow is Accurate: When calculating ROI or determining a multiple, be sure to use an accurate cash flow figure, which is usually going to be EBITDA. 

Account for Differences: The rate of return and multiples are only useful when comparing two investments that share similar criteria. Many business owners compare the returns on investment in their business to the returns of real estate or publicly held companies. But these comparisons aren’t often accurate because these different asset classes represent varying levels of risk. For example, ROI wouldn’t be suitable when comparing investments with the following differences in criteria:

Criteria	Investment A	Investment B
Time Frame	1 year	5 years
Leverage	0% Leverage	80% Leverage (or 80% of the investment is financed)
Potential	Similar investments generate returns of 4% – 6%	Potential annual returns of 25%
Risk	0.1% Failure Rate	50% Failure Rate

When comparing two investments, they should share the following similar criteria: 

• Time Frame
• Leverage
• Potential
• Risk

If they don’t, adjustments should be made to account for the differences. 

Conclusion

Multiples are the foundation of nearly every business valuation in the middle market. But while the math of calculating a multiple is simple, don’t let the apparent simplicity fool you. Just like a tennis racket or golf club is easy to swing, doing it properly is much more difficult. Understanding what multiples are and how they’re used is foundational to understanding how to value your business.