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An enterprise multiple is a type of ratio that is utilized to identify the current worth or value of a business. Also known as an earnings before interest, taxes, depreciation, and amortization or EBITDA ratio, this process calls for considering the worth of the company in a manner that is very similar to the way a prospective buyer would assess the business. One of the benefits of this approach is that the ratio tends to encompass more factors than some other strategies, notably the price-earnings ratio.
As part of the development of the enterprise multiple, several key factors that impact the overall value of the business are considered. Part of this is looking at the cash flow generated by the company. The idea here is to make sure that the amount of earnings that consistently flow into the business are sufficient to meet the costs of operation, and keep the business profitable. In order to accomplish this, the gross earnings must be compared to the level of debt that the company maintains, and the amount of payments that are made on that debt in each billing period.
A business that barely generates enough income to cover its costs of operation, including debt, and does not have much in the way of assets is said to have a low enterprise multiple. Businesses that have a healthy cash flow resulting in surplus would have a high enterprise multiple. One of the factors that can lead to an inaccurate calculation of the multiple is undervaluing the assets of the business. For example, if a business has earnings that barely cover expenses, and the assets are not considered, the enterprise multiple will be low. By allowing for those assets, especially those that can be converted into cash without negatively affecting the operation of the company, that low multiple may increase to a more desirable level.
There are several benefits associated with determining the enterprise multiple of a business. One has to do with providing prospective investors with information that motivates them to invest in the company. If the multiple is within a certain range, this is an indicator that the company is stable and the stock is likely to generate returns over time. It is also possible to utilize the multiple as a means of attracting buyers, if the current owners are interested in selling the company, assuming that the ratio is within a range that prospective buyers think makes the investment worthy of consideration.
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