The Multiplier Effecct

The reason central bank monetary policy works so well is because of the multiplier effect.

Basically, money we deposit in our banks doesn't just sit there collecting dust.  

The bank can and does lend that money to someone else.  

A hundred dollars deposited in a bank in in A, for example, may end up being loaned to an individual or a business in B.

After setting aside a small portion of each deposit as a reserve, banks are free to lend out the remainder.

The effect is to increase the money supply without any extra currency being printed.

What gets loaned out ends up in another bank to be subsequently loaned again.

How much should you pay for a business? Valuing a company (3)

Multipliers

Another simple approach is to use a multiplier to calculate a company's value. These multipliers will vary for different industries. One way of deciding what figure to pick for a multiplier is to analyse previous company takeovers within that sector, examining what was paid for these businesses compared to their sales or profit levels.

Caution must be taken in ensuring that the level of sales or profits in the accounting period being analysed is sustainable and does not contain one-off or abnormal conditions.

Sales multiplier

The sales multiplier uses a multiple of sales to assign a value to that company.

• This could be less than or greater than 1, depending on expectations for future growth. 
• Sales multipliers are particularly popular in start-up companies that are not yet profitable (eg. dot.com companies).

Profit multiplier
In the case of the profit multiplier, the multiplier used tends to be greater than 1 and will be based on 

• how many years' future profit are to be factored into the value of a business as well as 
• expectations for future profit growth.

So if a profit multiplier is 10 was used you might expect a 10% return for the next 10 years, with no change in business conditions to pay for this investment.

Also read:

Valuing a company (1)

Valuing a company using Asset Value (2)

Valuing a company using Multipliers (3)

Valuing a company using Market Capitalisation (4)

Valuing a company using Non-Financial Measures & Balanced Scoreboard (5)

Valuing a company using Cash Flows (6)