One Times Gross: Is that the Law?



One Times Gross: Is that the Law?

“Accounting practices are worth one times annual gross revenue.” This is a belief that has been around our profession for decades and, in fact, still drives the marketplace. No one can really explain why one times gross is such an accepted formula, but whatever the reason for the wide-spread thought, it is so persistent that many accountants do consider it some immutable law. At Accounting Practice Sales, we accept this mindset, using it to our advantage when possible and working to overcome it on other occasions.

This ubiquitous mantra implies that accountants value practices with reference to annual gross revenues. That actually is a bit strange. Almost all other small businesses are valued based on a multiple of net cash flow to the owner (including salary, payroll taxes, benefits, profits, etc.). This is commonly called discretionary cash flow. For all small businesses in North America that multiple is about 2.4 times cash flow to owner. The multiple for service businesses is less, more like 1.5 to 2 times. Therefore, if accountants were like everyone else, they would value their businesses at 1.5 to 2 times this discretionary cash flow. But they are different. Sometimes, where the cash flow is high for example, this mindset hurts the value of a business. At other times, like when cash flow is low, it helps the value.

Be aware that, despite our beliefs, not all practices sell at one times gross. One can no more say that than to say that houses sell for $X a square foot. Some do and some don't. There are a whole host of factors that will make a practice sell for more or less than another one. They include location, cash flow, type, size, etc. (See Key Factors in Practice Value on our website for more information.) One times gross is the starting point because that is what everyone thinks. But it is probably better to think in terms of a range like 80-120% of gross as being more realistic.

While one times gross is not a law it is certainly still very prevalent in the thinking of both sellers and buyers and cannot be dismissed. It is a general guideline and nothing more. It is best to realize, however, that prices do vary up and down from this standard. It is also best to remember simple economics. One, value is set by the buyer; sellers and brokers can determine an asking price but not the final value. If there are NO buyers, the practice is not worth anything on the current market. Two, in an efficient market quality will command a higher price. Three, the larger the pool of buyers there is the greater the demand and, consequently, the greater the value. Buyers and sellers will most likely get the best and fairest deals if they consider these principles. Sellers should realize that they need a good broker like those working within Accounting Practice Sales who understands these principles, can use them to maximum value and can create the best results.

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Source: Accounting Practice Sales

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