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Revenue vs Income Multiples in Valuing Web Businesses

Companies are valued according to the cash flow they generate. Cash flow is a “net” number, just like accounting profit is a net number. If value is derived from a net number like cash flow, why do so many web businesses valuations use a multiple of revenue?
The answer is that that a gross number like revenue is easier for a buyer to understand and interpret. A net number like cash flow is too subject to manipulation. It requires too many adjustments to be normalized.

The problem is that a buyer does not necessarily have confidence that your net numbers reflect reasonable expenses under the circumstances. Maybe you pay yourself less than the market rate in terms of employment salary, but make up for it with year-end bonuses.

Well a buyer, if prepared to use a cash flow multiple in valuing the business, would need to carefully analyze a series of expenses (related to salaries, rent, and other obligations) to determine what the operation of the business might look like in the hands of a financial buyer. This is called normalizing earnings or cash flow.

Because bottom line numbers like income are too subject to manipulation by the seller, many sellers stick to the top line when working up a valuation multiple. Revenue is much easier for a buyer to confirm. We can more easily get a handle on the prospects of the business through a revenue multiple.

Revenue is just not as susceptible to manipulation as cash flow or accounting profit can be. Therefore, revenue multiples are the preferred method of valuing web businesses.

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