Right after writing about the basics of valuing a business, I read another piece on valuations that make a great follow up. This piece is about the mistake of establishing a company's value based upon its revenue stream. Revenue is NOT income, folks. I'm always amazed with how many people make that mistake. Revenue is what you take in from your sales. Income (or earnings) is what's left after all your expenses have been taken out. *Cash flow is something altogether different and will be tackled later.)
Don't let the mathematical formula and charts scare you. Bill Gurley, a Silicon Valley venture capitalist and former Wall Street analyst, has written a readable piece about Price/Revenue valuations. His blog posting explores the dangers of looking at revenue streams in a vacuum. "All Revenue Is Not Created Equal" is a good piece because it gets into the difference between sustainable revenue that can feed real profits and create true equity value vs. the crude measures used by people caught up in the hype. The article talks about the inputs to the revenue and how the company is really going to make money. He tells you the questions to ask, such as "What are their margins?" When companies are starting out and growing, margins change and forecasting expenses and capital expenditures can be very fuzzy.
That's why Gurley tells people to beware and to think analytically. Price/Revenue ratios can be as low as 4X and as high at 100X. So when you're looking at hot investments, or if you're looking for people to give you capital for your own business, think critically about the sort of multiple of revenue or earnings or EBITDA your business really deserves. Don't rely on hype. Do your homework.