What is the relationship of net cash flow to ask price of a business?
A friend of mine is looking to buy a business. We see many businesses available with all different ask prices, gross sales, and net cash flow. I would like to know if there is a ratio of what the gross sales and or net cash flow should be to the asking price, or perhaps better, the actual sales price of a business. For example, if the net cash flow is $30,000 per year, should the business sell for $75,000, $100,000, $150,000, etc. in order for it to be a good investment?
Best Answer
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CUWu answered one year ago …
Couple of ways to go about it.
1. Apply a multiple to sales or earnings. The thing to remember with this method is that each industry has different multiples. While it might be foolish to buy a manufacturing company for 10 times sales, that's quite common in the tech industry. So I'd say first classify what type of business it is, then go to the public markets to see what types of average multiples these business get. You'll also want to discount that number a bit due to the fact that it's a private business. (NOTE: Many times, in a private transaction, and depending on the level of growth, 1 - 4 times sales is a good number...so if the business is showing NO growth, it's just doing $100,000 per year in sales, day-in-day-out, then $100k is a decent price, not a bargain or anything).
2. You can use a Discounted Cash Flow Model. But again, this equation heavily depends on the growth rate of that cash flow and how predictable it is. There are a ton of free DCF calculators on the web so I won't bore you with the equation here, but the most important factors to consider are the growth rate and how reliable all the numbers are (e.g. if the business has only been around 2 years you can't accurately predict what it'll do in sales next year).
Hope that helped Ethan, good luck!
