Many market participants and business appraisers refer to EBITDA as one measure of gross cash flow. Some business owners think about the value of their businesses in terms of rule of thumb multiples of EBITDA, say 4x to 6x, or 5x to 7x, or whatever, depending on the industry. However, Warren Buffet warns against “trumpeting EBITDA” as a “pernicious practice.” In light of both sides, we consider whether it can valuable to look at EBITDA in the context of two different public companies: Exxon and Apple. We introduce what may be a new concept in the EBITDA Depreciation Factor.

In this post we will discuss four important and interrelated concepts of value. We have talked about Market Value of Total Capital and Market Value of Equity in previous posts. It is now time to develop a clear understanding of what each of these terms means. We will also introduce a new term, Enterprise Value. We will also distinguish between the Market Value of Equity on an operating basis and the total value of equity of a business.

Businesses are financed with debt, equity and sometimes, preferred stock. We will not consider preferred stock in this discussion, because few private companies have it. The discount rate for developing MVTC, or Market Value of Total Capital, is called the Weighted Average Cost of Capital (WACC). In this post, we will discuss the concept of the WACC and its use as an investment tool, illustrate how to develop it, and then show how it can be used to develop indications of MVTC.

A discount rate is a rate that is used to discount, i.e., to convert, expected future benefits into present value. The idea of present value is fairly intuitive: A dollar received today is worth more than a dollar to be received in a month or a year. Business appraisers “build” discount rates using a concept known as the Capital Asset Pricing Model (CAPM). We walk through its components using a risk-free rate as a foundation and adding premiums. Using our assumptions, we can then build-up a discount rate.

After looking at the Gordon Model (and the DCF model) and understanding indications of the equity value of a business, we look at levels of earnings on an income statement. We consider how they relate to one another as well as how they convert to indications of value. Understanding the differences is critical so that we apply the right multiples to the appropriate and corresponding measures of earnings.

Business owners like to think they know what their businesses are worth. In most cases, unaided by professional valuation guidance, the typical owner will overvalue his or her business. We all like to think we are the exception, rather than the rule, or at the top of the value scale. It just isn’t so for most businesses. And it doesn’t matter what the owners think. In light of that fact, we consider what things do matter and why business owners should have a solid knowledge of what their business is actually worth.

In the prior post, we introduced the basic valuation equation and Gordon Model. In this post, we move on to Net Cash Flow and calculating a multiple as part of the equity value of a business. Despite the fact that many business owners don’t think of (Net) Cash Flow quite like this, the relationship between depreciation and capital expenditures and and working capital requirements impact value. Moving a step further, we dig into risk and growth, examining how each (and the change of each) impacts value.

The value of private companies, like that of public companies, is based on expectations regarding cash flow, growth and risk. Value is always future-based. There are virtually no external analysts following or even looking at most closely held and family businesses, regardless of their size. Quite large private companies will get attention from their banks and also from investment banks who hope to do business with them in the future. However, other than bank credit analysts who look at loan customer performance, there is little following and virtually no externally imposed management discipline. Value changes for private companies over time and with changes in external and internal conditions, even if no one is watching the change.