In the United Kingdom, current (2005) multiples for larger private companies are in the range from 4 to 9, whilst the P/Es for smaller companies range from 2 to 4. If you follow the steps suggested so far, you will probably come up with a figure for your business within this range.
Valuing a business using the P/E ratio method
Having established how to calculate the FMP and to choose the appropriate P/E ratio for your business, we will now look at how to value a business using this method. The steps involved are as follows:
Step 1: Establish the future maintainable profit (FMP) of the business after taxation.
Step 2: Select the appropriate P/E ratio (or capitalisation rate).
Step 3: Multiply the FMP by the P/E ratio multiple selected, to arrive at total business value.
Step 4: Add the value of surplus assets, if any, to arrive at total value.
Step 5: To value the goodwill, subtract the net tangible asset value from the total business value. (If the total value of the business does not exceed its net tangible asset value there will be no goodwill value. If total value is less than net tangible asset value there is ‘negative goodwill value’ and it can be assumed that the value of the assets in some other use exceeds the value of the assets in the business itself as a going concern.)
