Here are some thoughts from my past life as a business broker and appraiser.
mean vastly different things depending on context. Brokers and appraisers working with businesses with gross sales under, say, $2-5 million will usually use multiples of a number that is called different things, but amounts to how much cash could the owner/manager take out next year if he wanted to maximize his take without impacting the business. This means restating the income statement and eliminating expenses that are owner perqs such as the board meeting in Hawaii (oops - you are in Hawaii -- so maybe the board meeting in Minnesota?), the company car that is mostly used for commuting to and from work, unusual one-time events, sponsoring Junior's little league team, etc. Also added back are costs of financing (unless financing costs are a typical part of the business, as they are in, say, car dealerships), tax credits for depreciation and amortization, and a zillion other things. Brokers are supposed to, but often do not, adjust DOWN for the "real" depreciation, i.e., the reserve for replacement of stuff that wears out.
Brokers vary in how aggressively they approach these adjustments, and the results can go all over the place. But in the end, a potential buyer needs to agree with the rationale for the adjustments.
is far more objective, as no one has gone in and made adjustments -- they are what they are.
Multiples of the earnings described above and of gross sales are never
used by buyers to decide what price they are willing to pay -- there are far too many other factors involved. They are just used in reality checks, and often in establishing a price when a sale is not
contemplated, as in deciding on asset values in a divorce, etc.
, contrasted with small business buyers, value businesses differently, using, for example, discounted cash flows and comparative investments -- but those are almost never used when the buyer will be taking a full time role in the business, and almost never when the books aren't fully audited, the business sales in the many millions of dollars, and so forth.
What small business buyers do is very simple. They look at (a) can they make a living in the business, and (b) can they afford it?
Simple example: Someone buying a business that will reliably produce $100,000 available for owner compensation and financing will likely try to keep their annual debt service costs down to no more than 30-35% of that amount.
The roughly $33,000 per year in loan payments will support a loan of somewhere between $100,000 and $200,000. (Rates are high and terms are short, especially when the business lacks hard collateral such as marketable real estate and machinery.)
That leaves something like $67,000 for the owner to live on.
What does that say about the purchase price? Well, if the borrowed amount is in the $150,000 range, then the rest of the purchase price has to come from the buyer as a down payment. So how much is someone likely to pay as a down payment for something that will let them take home $67,000?
In practice, between the likely amount of liquid savings available for a down payment plus cash reserve for initial operations and the psychological aspects of paying out a lot of money and taking on significant debt, buyers will typically pay between a year's "pay" for them ($67,000) to a year's total cash flow ($100,000) as a down payment.
So, add the likely loan amount of around $150,000 to the likely down payment of around $75,000 and you get a purchase price of around $225,000, or 2.25x the $100,000 "cash flow" (commonly used term for the amount that the business can pay out to an owner-manager, as I described above).
For a business to get this 2.25 multiple of cash flow, it needs to be reasonably attractive to a buyer, offer a real promise of growth potential, have clean books, and a track record that makes all these numbers look very real, not just wishes. If things aren't so clean, then a multiple of 1 is well within the boundaries of typical sales, and when things are fabulous, multiples of 3 - 3.5 are sometimes encountered.
(What makes a business "fabulous" in this context? Very low risk, very stable earnings, very low complexity, etc. An example that comes to mind is a local burglar alarm monitoring company we had, where many hundreds of customers paid by automatic credit card debit for monitoring, the labor was cheap, and customer turnover was minimal.)
So when you hear that a business will sell for around a little over 2x cash flow, that is really an expression of what the market will bear.
You said you are hearing that a business is worth around 1/3 of the gross sales. That's an easier number to understand. It is simply based on what has happened.
I am posting below a couple of scanned graphs from stuff I was able to dig up from my old days. The first is a graph plotting sales price against the "cash flow" (as defined above) for a bunch of actual business sales. As you can see, the sales seem to average around 2x cash flow. The diagonal lines show the 25-75% boundaries and the 10-90% boundaries, so you can see that only the best 25% of businesses sold for more than 2.4x and only the worst 25% sold for less than 1.1x cash flow.
The second is a similar plot, but using gross sales instead of cash flow. The average selling price is 41% of gross sales. Only the best 25% sold for more than 58% of gross, and only the worst 25% sold for less than 25% of gross.
Hope this info helps you at least see how this stuff works...
And by the way -- lots of this info at http://www.valuationresources.com/
if you are a glutton for this stuff.