Earnings multiplier of 2 equals 50% ROI.

What Is The Multiplier?

At times when I use the term “multiplier” or “multiple” as a business broker, many business owners screw up their faces and go “What?”. So I thought I might explain it here for your benefit.

The multiplier is the number of years it takes to recoup an investment in a business, based on the value of money today. For example, if I bought a business at $350,000 and EBIT (earnings before interest & tax) is $100,000 a year, then the multiplier for that business is the purchase price of the business divided by EBIT, which is 350K / 100K = 3.5x.

If we raise the profit to $150,000 a year, then the multiplier lowers to about 2.3x.

So a rule of thumb is – the smaller the multiplier, the more money it makes (and vice versa). But always keep in mind… if a business makes more money in a shorter amount of time, there’s probably a higher level of risk involved as well.

It’s Not All About Earnings!
However, the word “multiplier” need not only apply to earnings. It can also apply to sales, or to put another way, a business can be roughly appraised on its weekly or annual turnover. As an example, convenience stores are generally appraised on their weekly sales. So if a store does $15,000 a week, you might obtain a very rough indication of its value by multiplying it by 10 – the industry average in Queensland, Australia (as of October 2009). So an indicative price of the business might be $150,000.

So whenever you hear the word ‘multiplier’, you should clarify whether they’re talking about earnings or sales.

How About ROI or P/E?
You can also convert the earnings multiplier into a ROI (return on investment) figure by calculating 1 divided by the multiplier. So if you have an earnings multiplier of 2, 1 divided by 2 equals 50% ROI.

And also for all you share investors out there, the earnings multiplier is exactly the same as the P/E ratio (price earnings ratio).


http://www.businessforsaleblog.com.au/what-is-the-multiplier/