Is turnover a good way to value a business?

Why do people ask about turnover?

Turnover is the most visible number in a business. It appears first in the accounts, it is easy to compare, and it is often the figure owners use to describe the size of their business. Rules of thumb expressed against turnover circulate widely, too.

The difficulty is that a buyer is not paying for sales. A buyer is paying for the profit those sales will generate under their ownership, and for how confident they can be that it will continue.

Same turnover, different businesses

Illustrative example. Companies G and H are fictional; the figures are invented. No value is shown for either business.

Turnover. Company G: £1.0 million. Company H: £1.0 million.

Normalised EBITDA (after the market cost of the owner's role). Company G: £150,000. Company H: £40,000.

Revenue. Company G: Mostly from annual service agreements with around 120 customers. Company H: Mostly one-off projects, with two customers providing over half of sales.

Owner's role. Company G: Manages a team that runs day-to-day operations. Company H: Wins most of the work and prices every job personally.

Both businesses have the same turnover. A buyer would see them very differently:

• Company G earns almost four times as much from the same sales. Its revenue is spread across many customers, much of it repeats, and the business does not rely on the owner day to day.
• Company H earns much less. Its revenue has to be won again each year, it depends on two customers, and it depends on the owner.

Any valuation based on turnover alone would treat them as equivalent. A valuation based on maintainable earnings and risk would not.

What do buyers look at instead?

For a profitable owner-managed business, the usual starting point is:

1. Maintainable earnings: what the business earns in a normal year, after normalising the accounts – including the market cost of the work the owner does.
2. The risks attached to those earnings:
3. • how recurring the revenue is;
   • how concentrated the customers are;
   • how dependent the business is on the owner;
   • how reliable the financial information is.
3. What the owner will receive: cash, borrowings, working capital and deal terms all sit between the value of the business and the amount the owner keeps.

Our complete guide to valuing a small UK business explains each step, with a worked example.

When does turnover matter?

Turnover is not irrelevant. It matters as context:

• Scale. Larger businesses often attract a wider pool of buyers.
• Trend. Growing, stable or falling sales tell a buyer how the earnings are likely to develop.
• Quality of revenue. How much is recurring or contracted, how concentrated it is, and how it is priced.
• Businesses that reinvest heavily or are not yet consistently profitable. In some cases buyers focus more on revenue and its quality. Even then, the question is how much profit the revenue can produce under the buyer's ownership – revenue is a step towards that answer, not a substitute for it.

What this means in practice

If you want a first view of what your business might be worth, start from profit rather than sales:

1. take profit before tax from the accounts;
2. add back interest, depreciation and the working owners' pay;
3. remove one-off and personal items;
4. deduct the market cost of the owner's role.

Then look honestly at the risks a buyer would see. That gives a far better starting point than any figure based on turnover.

How Proplexo can help

Our Strategic Valuation Review is a practical valuation focused on both current value and what could improve it, based on normalised earnings and the factors a buyer will focus on.

This article is general information for owner-managed businesses, not advice on your circumstances.