How to Value an Engineering Firm
Engineering firms play an important role for many businesses and other entities. Operators in this industry use engineering to create and work with instruments, structures, machines, systems, and processes. Engineering firm services often include consulting, feasibility studies, construction services, etc… According to IBIS World, the engineering firm industry retains steady demand. This is ideal for those looking to buy, grow, or sell an engineering firm. However, this industry is very fragmented and competitive. To succeed, it is important to learn about the risks associated with engineering firms. To do so, consider learning how to value an engineering firm.
You can learn how to value an engineering firm by receiving a business appraisal. As part of a business appraisal, a valuation expert assesses the strengths and weaknesses of an engineering firm. This is beneficial if you are looking to buy, expand, or sell an engineering firm. Peak Business Valuation, business appraiser, works with engineering firms across the country. We are happy to provide you with a business appraisal for an engineering firm. We can also answer any inquiries you may have on how to value an engineering firm. Schedule a free consultation with Peak Business Valuation below!
How to Value an Engineering Firm
There are various valuation approaches a valuation analyst may use to value an engineering firm. Peak Business Valuation often uses the market approach and/or the income approach. Each approach uses a different basis of valuation. As part of a business appraisal, the business appraiser will determine which method is best for your engineering firm. This can include using a combination of valuation approaches.
Valuing an Engineering Firm Using the Market Approach
The market approach is common when valuing an engineering firm. The market approach is similar to the approach that a real estate appraiser uses to value a property. Real estate appraisers compare the house to similar homes that have recently sold in the same area. This helps them accurately determine the value of the property. When using the market approach to value an engineering firm, a business appraiser compares similar businesses that recently sold. If the firm is private, the valuation expert refers to private transaction databases to gather information.
Multiples for an Engineering Firm
Valuation multiples are a key component of the market approach. Valuation multiples are financial ratios that measure an engineering firm’s value based on a financial metric. These metrics often include cash flow, sales, and earnings. To determine the valuation multiples for an engineering firm, business appraisers use the proper NAICS or SIC code. Below, we discuss basic valuation multiples for an engineering firm.
SDE (Seller’s Discretionary Earnings) Multiple for an Engineering Firm
- The SDE multiple is popular when valuing an engineering firm. Business appraisers apply the SDE multiple to the seller’s discretionary earnings of an engineering firm to determine its value.
EBITDA Multiples for Engineering Firms
- The EBITDA multiple helps engineering firms calculate the expected return on investment (ROI).
REVENUE or SALES Multiples for an Engineering Firm
- REV multiples measure the total amount of revenue or sales an engineering firm generates. Valuation experts apply the multiple to the revenue of the engineering firm to determine its fair market value.
The valuation multiple a business appraiser uses depends on various factors. To learn more about how to value an engineering firm using the market approach, see Valuation Multiples for an Engineering Firm.
Valuing an Engineering Firm Using the Income Approach
Another common valuation approach for valuing an engineering firm is the income approach. This approach assesses value based on the future earning potential of an engineering firm. In addition, the income approach assesses the risks an investor may encounter when buying or selling an engineering firm. We discuss a few of these risks below.
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- Key Personnel: To operate a successful engineering firm, it is vital to have skilled engineers. This ensures high-quality work and improves the reputation of an engineering firm.
- Competition: The engineering firm industry is extremely competitive. As such, operators must find ways to differentiate from competitors.
- Regulations: There are many regulations associated with engineering. Failure to comply with these regulations may have detrimental consequences for an engineering firm.
- Technology: Technology plays an important role in modern engineering. It is important for an engineering firm to have high-quality engineering technology.
Methods to Value an Engineering Firm Using the Income Approach
There are two common methods under the income approach that valuation analysts when deciding how to value an engineering firm. They are the capitalization of cash flow method and the discounted cash flow method. Below, we discuss these valuation methods for valuing an engineering firm.
Capitalization of Cash Flow Method
- Business appraisers generally use the capitalization of cash flow method for engineering firms with stable histories. When using the capitalization of cash flow method, the business appraiser determines an appropriate measure of income for a certain period. This income is then divided by a reasonable capitalization rate. The capitalization rate represents an appropriate rate of return a buyer can expect from the firm. The capitalization of cash flow method also assesses the risks an investor may encounter.
Discounted Cash Flow Method
- The discounted cash flow method is best for valuing engineering firms with strong financial histories. This method is also beneficial for engineering firms with reliable forecasts. When using the discounted cash flow method, valuation analysts rely on 3-5 years of cash flow projections. Then, the analyst discounts future cash flows using a discount rate rather than a capitalization rate. Keep in mind, this method is less common since it relies on future cash flow estimates which can be unreliable.
Summary
When valuing an engineering firm, business appraisers may use various valuation methods. Often, they use the market approach and/or the income approach. These methods present important insights to help an appraiser determine the value of an engineering firm. To know which method is best for your engineering firms, receive a business appraisal. As part of a business appraisal, you will learn the fair market value of an engineering firm. This is important whether you are buying, growing, or selling an engineering firm.
Peak Business Valuation, business appraiser, works with engineering firms on a regular basis. Peak is happy to provide you with a business appraisal for an engineering firm. We can also answer any questions you have about how to value an engineering firm. Start now by scheduling a free consultation with Peak Business Valuation below!
For more information see also Valuing an Engineering Firm, Value Drivers for an Engineering Firm, and Valuation Multiples for an Engineering Firm.
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