What is Benchmark Valuation? All You Need to Know

Introduction

It’s important to know your business’s worth. However, there is no one-fit-for-all method for valuing the business’s worth. Every business is unique, and so is their valuation.

Here, one of the methods you can go for is finding out how other firms spent on similar earnings. You can choose this benchmark valuation method if you just want a basic estimate of the worth of your firm in terms of your competitors.

Let’s discuss benchmark valuation.

Benchmark Valuation Meaning

Benchmark valuation is a method of comparing your business performance against that of your competitors.

Benchmark value of your business can be helpful for various business purposes, such as:

• Business Planning
• Merger & Acquisition
• Estate Planning
• GST Complications
• Taxation of Capital Gain Planning
• Partnership Dissolution
• Transaction Procedures
• Organization planning
• Managerial buy-out
• State Transfer Obligation
• Family Law

However, there are some considerations you need to measure before valuing benchmarks. Let’s understand that.

Considerations Before Conducting Benchmark Valuation

Before conducting a benchmark valuation, it is important to evaluate these three financial indicators:

1. Revenue

The total amount of money a business earns from all its operations. It is a top metric because it excludes all costs of the company.

2. EBITDA

Earnings before interests, tax, depreciation, and amortization (EBITDA) are the company’s earnings before deducting the costs of interests, tax, depreciation, and amortization.

3. SDE

The seller’s discretionary earnings (SDE) can be measured by adding the owner’s pay to EBITDA. It’s a type of earning metric for business operators and owners.

Now, we can evaluate the industry benchmark with strategies which are given below:

Strategies for Valuing Industry Benchmarks

1. Focus on financial record benchmarking

• First, set up an industry comparison benchmarking so that analysts can determine where the firm belongs in the value range.
• This value range can also help in getting the price range of transactions, such as a firm’s sold price for a specific industry.
• Financial record benchmarking information helps analysts determine the market value spectrum, where the result appears as a risk rate or multiple in valuation.

2. Understand industry average statistics

• Then take complex data from various industries as a common size average of income statements, balance sheets, and ratio analysis.
• This data is given in average rather than median by industry sources because the results or estimates will not stand out if provided in medians.
• You can understand the difficulties with numbers here, but it can be solved.
• Because when outliers are eliminated, medians can provide a better analysis of industry performance indicators.
• However, the values of the average and median vary in several ways in the data. For instance, valuing medians increases credibility.
• Most of the data analysts prepare data points at the 25th, 50th (medians), and 75th percentile.
• You need to analyze the thorough study of all the utilized data.

3. Develop a strong base for data

• Statistics helps in valuation, but you need to understand the data first. If you can identify what data tells you, you can apply accurate value in benchmarking.
• For instance, if your data says, “Your company is 10% over the industry range for gross profit.”, then you have a volatile benchmark which is difficult to interpret or apply to a value.
• We know the company is performing better than the industry but actually how much? What does it clarify? How can we apply this to valuation? It is not easy to interpret.
• Rather, you can assess how the company competes in the industry using the data that tells the whole industry rating, i.e.,10 to 90 percentiles.

4. Consider the existence of the industry range

• Most benchmarking data sources interpret a single data point as an industry. A single number, whether average or median, shows the center. If the data source is trustworthy, that will show the low or high observations.
• However, it is insufficient to interpret where the company is heading by just comparing a single data point of the industry range.
• Even if the standard deviation is supplied, there are chances of volatile results.
• Comparisons should not be interpreted as three-tier correlations such as “the company is average, below average, or above average.
• Prepare the industry range as accurately as possible so that it can increase the credibility of benchmarking.

Benchmark Valuation Process & Approach:

• The process of calculating valuation multiples and comparing these multiples against similar companies is called benchmarking. So, the benchmarking is based on the assumption that similar kinds of companies have similar value multiples.
• You must consider the industry and company which are similar in business categories, market range, location, and some other similarities.
• The process of benchmark valuation starts when you compare a company’s financial indicators with similar-nature companies’ financial indicators.
• These financial metrics are translated into ratios for companies varying in size.
• The effective way of benchmarking is to include many organizations in a certain industry and then calculate the median or center of the collected stats.
• Mostly, the median is preferred because it excludes outliers that might affect the average.
• To get the approximate value of the company, analysts compare the median or occasionally average selling price ratios for the industry. Then they arrive at a final answer by assigning a weight to each estimated value.
• Here, the sales or EBITDA may be more critical than the SDE, so value is given greater weight.

Benchmark Valuation Methods

• Some analysts measure the median or occasionally average to get the final answer.
• Analysts often use the center value by arriving at a certain figure as per the industry or given size.
• Every valuation multiple also generates an estimated value. Then you can add a weight to each estimated value to arrive at the final answer.
• In some companies, revenues, or EBITDA, are more critical than their earnings. That value may give greater weight.
• You need to ensure that benchmark valuations are specified with purpose and comply with:
  1) Indian Valuation Standards(IVS) established by the ICAI’s Valuation Standards Board (VSB),
  2) FASB (Financial Accounting Standards Board) guidelines,
  3) IRC (Internal Revenue Code)
• You can also check out benchmark valuation service provider firms or benchmark valuation platforms to get accurate value.

What should all benchmarking reports contain?

Benchmarking reports evaluated among similar companies in the industry. It is necessary to assess financial and non-financial aspects such as:

1. Customer Base Growth

Benchmark valuation reports should consider the customer base in the overall business growth. Customers’ databases, records, transactions, and reviews help to value businesses accurately.

2. The Territory of Operation

Evaluating the business’s operation region is also an important aspect of benchmarking. The firm should consider the geographical, political, and economic factors of the particular location in the benchmarking process.

3. Comparison with the Best

Comparing the business with the best-performing firm in the industry helps to identify the improvement areas for the business. This aspect can also be used in comparing best practices and strategies to implement them effectively.

Conclusion

Depending on your business size, industry, or consumer base, your business needs to know its worth, which helps you to plan and strategize accordingly. You can examine the benchmark for your company by the methods and approaches we discussed in the blog, still, you can go to an expert valuer for accurate valuation because of their specialized knowledge and experience in valuation.

As a certified business valuation firm in India, We, at My Valuation, provide valuation services for various purposes. Our business valuation, start-up valuation, ESOP valuation, and more are preferred by many businesses.

If you are looking for a professional valuation services firm for your benchmark valuation, then contact us, we are here to serve you industry-best valuation services.

Frequently Asked Questions

Why is benchmark valuation essential?Benchmark valuation is essential for any business because it makes businesses aware of competition, improves performance, enhances quality in business operations, helps in planning and strategy, etc.What are the types of benchmarking?There are three types of benchmarking:
1) Internal benchmarking,
2) strategic benchmarking, and
3) strategic benchmarking.What is the procedure for benchmarking?The procedure of benchmarking:

• • Select a subject to benchmark.
  • Select the companies or businesses you wish to benchmark.
  • Keep note of your current procedures.
  • Collect data and analyze
  • Compare your performance to the data you’ve analyzed
  • Make a strategy
  • Implement changes if needed

What are the calculation methods for benchmark valuation?You can conduct the benchmark valuation by the price-earnings (P/E), the price-book (P/B), and a combined price-earnings and price-book (P/E-P/B) methods.
What is necessary for all benchmark documents?Benchmark documents should contain the consumer growth, territory of operation, understanding of the geographical, social, economic, and political variables, and comparison with the best company.