Valuing Businesses Using Regression Analysis

CHAPTER 4Cash Flow Multiplier Regression

EXHIBIT 4.1 SDE% vs. Cash Flow Multipliers

The logic surrounding the use of regression to predict revenue multipliers makes perfect sense—the higher a company's level of profitability, the higher its revenue multiplier will likely be. However, this logic is completely the opposite when calculating cash flow multipliers. If we go back to Exhibit 2.1 and retrieve the SDE% and cash flow multipliers for each of our 24 transactions, the graph will look like Exhibit 4.1. Amazingly, there is an inverted relationship between a company's level of profitability and its cash flow multiplier!

As we move to the right on the X‐axis, the cash flow profit margins increase. However, we notice that as we moved right, the dots representing the transactions move lower and lower on the chart, indicating a smaller cash flow multiplier.

In other words, the greater the level of a company's profitability, the lower its cash flow multiplier.

This is just counterintuitive. After all, we have always been taught that the more profitable companies have a tendency to sell for higher prices. That axiom is still true. But when an appraiser determines the appropriate cash flow multiplier for the subject company, he is not using the actual cash flow from the sample's transaction in his calculations. He is using a ratio. That ratio is the selling price ÷ SDE—the cash ...