This method is suitable for companies with an established financial history. The price/earnings (P/E) ratio represents the value of the business divided by its after-tax profits. Two factors influence the earnings multiples:
1. The earnings: These should be “normalised” - in other words, all one-off items should be adjusted for - and the best estimate for the next 12 months.
2. The ratio: This should reflect all known risk factors - the higher the risk, the lower the ratio and vice versa - and will be in the range of three to eight for most unlisted companies.
This is the predicted cost to set up a similar business to the one being sold. It includes the cost of developing a customer base and reputation, recruiting and training staff, purchasing assets as well as developing products and services.
There are also a large number of other factors that may be taken into account:
- Economic climate
- Intangible assets
- Reasons for sale
- Due diligence