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Valuation: Recurring Revenue Stream
When valuing a business, the appropriateness and weight given to each valuation method often depends on the specifics of the industry, the business’s financial structure, and its growth prospects. However, for a services business with recurring revenue streams, some methods will generally be more relevant than others.
Here’s a general guidance on weighting for each scenario.
High Recurring Revenue Stream
| Valuation Method | Weighting | Rationale |
| Return on Investment (ROI) Valuation | Low (5%) | While ROI is always of interest, businesses with high recurring revenue may be valued more on their stability and growth potential. |
| EBITDA Multiplier | Medium (15%) | EBITDA provides a clear picture of operational profitability without the effects of financing decisions. |
| Simple Cash Payback | Low (5%) | High recurring revenue businesses typically have longer horizons; simple payback might be too short-sighted. |
| Revenue Multiplier Valuation | High (25%) | The predictability of recurring revenue can make revenue-based multipliers particularly relevant. |
| Balance Sheet Valuation | Low (5%) | Service businesses often have fewer tangible assets, making this method less relevant. |
| Discounted Cashflow Valuation (DCF) | High (35%) | Predictable, recurring revenues lend themselves well to DCF analyses since future cash flows are more easily forecasted. |
| Cash Flow Valuation | Medium (10%) | Steady recurring revenue makes cash flow a relevant metric, but DCF might capture future value more accurately. |
Low Recurring Revenue Stream
| Valuation Method | Weighting | Rationale |
| Return on Investment (ROI) Valuation | Medium (15%) | Investors will be keen to understand ROI given the less predictable revenue. |
| EBITDA Multiplier | Medium (15%) | EBITDA remains relevant but might be less predictable. |
| Simple Cash Payback | Medium (20%) | The uncertainty of revenue makes understanding payback periods more crucial. |
| Revenue Multiplier Valuation | Low (10%) | Given the inconsistency in revenue, this might be less reliable. |
| Balance Sheet Valuation | Medium (15%) | In the absence of strong recurring revenue, tangible assets might be more closely scrutinized. |
| Discounted Cashflow Valuation (DCF) | Low (10%) | Less predictable revenue makes accurate forecasting challenging. |
| Cash Flow Valuation | Medium (15%) | Understanding how much cash the business can generate becomes crucial, given the unpredictable revenue. |
It’s worth noting that these weightings are general guidelines. The specific nature of the services offered, industry benchmarks, competitive landscape, and other factors would also influence the weightings.
Always consult with a valuation expert or financial advisor when assessing a business’s worth.
