Published on
December 20, 2024
The accounting industry, a cornerstone of modern commerce, provides essential services such as auditing, consulting, and account preparation to individuals, businesses, and various entities. Accounting services are indispensable, enabling organizations to maintain compliance, make informed decisions, and strategize for the future. Without these services, businesses would face significant challenges in navigating financial complexities. Consequently, the demand for accounting services remains steady, with substantial opportunities for growth and investment. According to IBIS World, there are approximately 88,000 accounting firms in the United States, collectively generating over $144 billion in annual revenue. Given this robust market, the current climate may present an ideal opportunity to buy, grow, or sell an accounting firm. However, whether you’re entering or exiting the industry, understanding valuation multiples is crucial for informed decision-making.
Valuing an accounting firm is a multifaceted process that offers numerous benefits. Whether buying or selling, an accurate valuation lays the foundation for strategic planning. For prospective buyers, a business valuation helps determine a fair purchase price, enabling them to avoid overpaying while also providing insights into effective negotiation strategies. For sellers, a valuation helps identify opportunities to enhance the firm’s value and establish a fair listing price, making the sale process smoother and more profitable.
Business appraisers use a variety of methods to assess the value of an accounting firm. Among these, the market approach—which involves the use of valuation multiples—is particularly common. This article will explore the key valuation multiples relevant to accounting firms, providing a detailed guide to their application. It’s important to note that while this article uses average industry values for illustrative purposes, the specific circumstances of your accounting firm may lead to different results. Therefore, obtaining a professional business valuation tailored to your firm’s unique characteristics is essential.
At Phoenix Strategy Group, we specialize in providing business valuations for accounting firms across the country. Our team of experienced appraisers is here to answer your questions and guide you through the valuation process. To get started, schedule a free consultation with us today.
A valuation multiple is a ratio that compares a business’s value to a specific financial metric, such as cash flow, earnings, or revenue. By analyzing these multiples, appraisers can estimate a firm’s market value based on the performance of similar firms that have recently been sold. The use of valuation multiples allows for a standardized approach to assessing value, making it easier to compare different firms.
One common example of a valuation multiple is the Seller’s Discretionary Earnings (SDE) multiple, which compares the seller’s discretionary earnings to the implied value of the business. Other commonly used multiples include EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and REV (Revenue) multiples. Let’s delve deeper into each of these multiples and their application in valuing accounting firms.
Average SDE Multiple Range: 1.81x – 3.25x
Seller’s Discretionary Earnings (SDE) is a key metric in small business valuations, as it includes the business’s profit as well as discretionary expenses, such as the owner’s salary, personal expenses, and non-recurring costs. The SDE multiple is calculated as follows:
SDE x Multiple = Value of the Business
For example, consider an accounting firm with $275,000 in seller’s discretionary earnings. If it transacts at a 2.51x multiple, its implied value is approximately $690,250:
$275,000 x 2.51 = $690,250
SDE multiples are particularly popular in accounting firm valuations because they provide a clear picture of the cash flow available to a potential buyer. This multiple also accounts for adjustments that normalize the earnings, such as removing one-time expenses or owner-specific costs. However, the specific multiple applied can vary based on factors such as the firm’s size, location, client base, and overall market conditions.
SDE multiples also have the advantage of simplifying the buyer’s evaluation process. By providing a single, clear figure representing profitability after normalization, buyers can more easily compare multiple firms. For sellers, focusing on SDE can highlight areas of improvement that can directly enhance value, such as reducing unnecessary expenses or diversifying revenue streams.
Average EBITDA Multiple Range: 2.99x – 4.45x
EBITDA is another widely used metric in business valuations. Unlike SDE, EBITDA focuses on the firm’s operating performance, excluding the impact of financing, tax strategies, and capital expenditures. This makes it an attractive metric for larger firms or those with more complex financial structures. The formula for applying an EBITDA multiple is as follows:
EBITDA x Multiple = Value of the Business
For instance, an accounting firm with an EBITDA of $200,000 that transacts at a 3.66x multiple would have an implied value of $732,000:
$200,000 x 3.66 = $732,000
The use of EBITDA multiples is advantageous because it provides a normalized basis for comparison between firms. By excluding variables such as capital structure and tax strategies, this multiple offers a clearer view of the firm’s profitability. Additionally, it helps buyers estimate the return on investment (ROI) they can expect. However, like SDE multiples, the specific EBITDA multiple applied will depend on various factors, including the firm’s growth prospects, industry trends, and competitive position.
EBITDA multiples are especially valuable for firms with a significant number of fixed assets or varying debt levels. They offer insight into the true operating potential of the firm without external financial factors muddying the waters. For both buyers and sellers, this clarity can be invaluable during negotiations, ensuring both parties have a comprehensive understanding of the firm’s value.
Average REV Multiple Range: 0.71x – 1.09x
Revenue (REV) multiples are less commonly used in small business valuations but can still provide valuable insights. This metric focuses solely on the firm’s top-line revenue, offering a straightforward approach to valuation. The calculation for applying a REV multiple is as follows:
Revenue x Multiple = Value of the Business
For example, an accounting firm with $757,000 in annual revenue that transacts at a 1.01x multiple would have an implied value of approximately $764,570:
$757,000 x 1.01 = $764,570
REV multiples are often influenced by industry-specific factors, such as market demand, location, and competition. However, they do not account for expenses or profitability, which can limit their usefulness for smaller firms. For this reason, cash flow-based multiples such as SDE and EBITDA are generally preferred for valuing accounting firms, as they provide a more comprehensive view of the firm’s financial health.
While REV multiples might not capture profitability, they can be useful in assessing firms in growth phases or with significant revenue potential. They offer a broad benchmark for buyers who are less concerned with immediate profit and more interested in future scaling opportunities.
While the ranges provided above offer a general guideline, the specific multiple applied to your accounting firm will depend on various factors. These include:
Each of these factors contributes to the overall perception of risk and opportunity in a transaction. By addressing potential weaknesses, such as an over-reliance on a single client or market, sellers can position their firm more favorably to potential buyers.
If you’re planning to sell your accounting firm, taking steps to enhance its value can help you achieve a higher sale price. Consider the following strategies:
Valuing an accounting firm is a complex process that requires careful consideration of multiple factors. By understanding and applying valuation multiples such as SDE, EBITDA, and REV, you can gain valuable insights into your firm’s market value. However, it’s important to remember that these multiples are only part of the equation. A professional business valuation tailored to your firm’s unique characteristics is essential for accurate results.
At Phoenix Strategy Group, we specialize in helping accounting firms navigate the valuation process. Whether you’re looking to buy, grow, or sell, our experienced appraisers are here to provide the guidance you need. Contact us today to schedule a free consultation and take the first step toward achieving your goals.
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