In determining the value of a business, how important is it to consider the earnings percentage - i.e. earnings as a percentage of overall revenue? All things equal, if I'm looking at businesses with a certain amount of earnings, am I better off with a business with lots of revenue, and relatively low earnings percentage, or a business with a high earnings percentage and much lower revenue?
These are all excellent questions! I think it's difficult to simply broad brush an answer to you specifically because different businesses/industries will have a wide range of earnings as a percentage of revenues. As an example, service business will typically enjoy enormous margins compared to distribution companies. Therefore, if you wish to have this figure play a significant role, your only considerations should be: is the net profit percentage after add-backs in line with industry standards and, second, how do the profits of one compare to their like businesses.
The question of which is better: higher profit percentages or revenue is strictly personally. I certainly prefer businesses that have higher margins, and I am less focused on the revenues. In fact, of my five golden rules that any business must have, high margins is one of them (the other four are: sales and marketing driven, element of exclusivity in product/territory, demand in place, don't compete on price). The reason why high margins are more important to me is because my strength is in sales and marketing. I know I can build a business' sales and so if the margins are strong, the profits will surely follow. Conversely, it is difficult if not impossible to significantly impact the margins of a business. Sure you can cut expenses but the only long-term meaningful way to build a business is to grow the revenue. Therefore, if the margins and profit percentages are good, you'll experience meteoric increases in profit as you significantly increase sales.
So in a long winded way, my preference would be to pay more attention to the profit percentages unless you're considering an industry with traditionally low margins and one that you are very familiar with operating.
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|Richard Parker is the author of: How To Buy A Good Business At A Great Price, the most widely used reference resource and strategy guide for buying a business. He has purchased ten businesses in his career and has helped thousands of prospective buyers worldwide learn how to buy the right business for sale. He is also founder and President of Diomo Corporation - The Business Buyer Resource Center.|