Now that we understand the complexities and business conditions that affect the valuation of an engineering firm, we can now look into some common valuation practice in the engineering industry.
There are multiple methods of valuing firms such as using multiples of book value, price-to-earnings (P/E) ratios, discounted cash flow and multiples of earnings before interest, taxes, depreciation and amortization (EBITDA).
The most popular method in most countries like Singapore, Malaysia, Hong Kong, Australia and United States is the EBITDA method. The valuation method is another way of describing pretax cash flow, and engineering firms typically sell for a multiple of 1.5 to 3.0 times EBITDA plus a percentage of assets. In addition to the EBITDA, principals’ compensation (i.e., distributions) in excess of a normal compensation package should be added to cash flow. By projecting current or average of recent years EBITDA, it is possible to estimate a future firm sale price.
Less common methods of getting a general idea of fair valuation include using 40 to 50 percent of net service revenue, 30 to 40 percent of gross services revenue, or multiplying $60,000 – $70,000 by the number of full-time equivalent employees of the company.
These measures assume a certain level of profitability and growth. These are generally not sufficient to rely upon in determining value as they ignore many of the individual characteristics of a firm. However, they can provide a great sanity check in support of other more detailed valuation methods.
Two firms with very similar gross or net revenue can have very different profitability. A firm with atypical performance in one year will need to normalize its results in order to make these rules of thumb relevant.
Hence in accurately valuing your engineering firm, it is critical that you engage a professional to assess the valuation of your business based on all the variables and prospect of your business instead of using general rule of thumb approaches.
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