It's not quite that simple. There is more that goes into valuation of a company.
Cash flow and how that cash flow is treated is critical, as are many other factors. Economic as well as finanical analysis is needed.
Many of the variables that go into cash flow models are uncertain, so you have to choose to incorporate probabilities into the cash flow modeling. The goal of developing the cash flow is to compare the timing and magnitude of the flow with the timing and magnitude of flows resulting from alternative uses of your money(speaking from a buyers standpoint).
Cash flow is made up of: 1) Revenue (from goods or services), 2) Cost (cash spent in making, operating, and marketing), and 3) Terms (how the revenue and costs are treated (i.e. taxes, financing, payment terms, etc.)
Revenue - Cost - Taxes = net cash flow.
Revenue needs to be looked at and a simple forecast model developed. Costs need to be looked at in the same way. Cash flow risk needs to be considered as well as taxes (never forget to consider taxes in ANY decision you make). Once you determine the cash flow you will need to look at cash flow treatment which is a whole other issue. What are the contract terms with suppliers? Customers?
Bottom line is you will need to, after analyzing all of the inputs to the equation R - C - T = NCF, still need to determine the effecieny of the investment. Calculating NPV (Excel does that easily, you'll need to select a discounting rate, 10% seems to be the commonly acceptable rate) - but this will only tell you the magnitude of the investment. In other words, NPV is an indicator of the value generated by an investment, but gives no indication of the relative investment efficiency, other than generating greater than a 10% return if the NPV is positive.
You also need to look at ROR (rate of return), ROI (return on investment) DPI (discounted profitability index), IRR (internal rate of return), or there are a multitude of other ratios that will tell you what the effeciency of the investment is based on a number of factors. There is no silver bullet to dtermine yea or ney. Personally, DPI and NPV I think are the best conbination of primary metrics to use for investment decision-making, because they cause alternatives to be evaluated with the mindset of the highest efficiency for the investment (DPI) and for adding value (NPV).
Spending additional investment as long as it adds positive NPV or value at a ten percent discount rate does not indicate good investment efficiency, as value may only be added at a 10% effective rate or a 1.0 DPI. DPI values above 1.0 indicaet that value is being added at a rate higher than the 10% disconnt rate.
To take the example above and assume the $300K in salaries @ 300% billing = $900K, assume 10% net profit = $90k/yr. What would you pay for that cashflow? Again, have to make many broad assumptions here, but at 10% discount rate, assume you'll keep the business 25 years, no residual value (all of these are very broad assumptions), a normal investor would pay $800k for the business.
GregLocock summary of the problem areas is unfortunatle yaccurate. All of this only underscores the fact, that if you want to sell, get some professional input.
Greg Lamberson, BS, MBA
Consultant - Upstream Energy
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