Click here to get this post in PDF
Business valuation is a process that helps business owners determine their company’s value in the market. Most companies conduct this analysis when they are planning to sell the business or trying to attract new investors.
However, there are different factors to consider while estimating the market value of a company. Therefore, some organizations prefer a business valuation company to collect actual data and use various valuation methods to determine accurate results.
Business Valuation Approaches
Due to multiple factors impacting the business valuation results, there are numerous approaches that help determine a firm’s value.
Market Value Method
The market value method is a subjective approach to evaluating the final worth of a company. In this approach, the organization’s assets and shares’ selling prices are compared with a similar company that has been sold recently.
The success of this method depends on accumulating comparative data of the competitors. For this reason, a business valuation company comes in handy, as the experts are more experienced in gathering actual data for analysis. A professional business valuator can gather accurate data that is difficult for a company representative to access.
Once the data is collected and compared, the company acquires a rough estimate of its assets’ worth. However, this valuation process does not present concrete results. Therefore, combining it with another business valuation method is a better approach.
Another way to use the market value method is by multiplying the number of outstanding shares (stock held by shareholders) by the current share price. This way, companies can learn their stock value. However, it is difficult to determine fixed-income securities and illiquid assets through this model.
In the asset-based valuation method, organizations determine their assets’ current value. Then, liabilities are extracted from total assets to learn the fair market value. The asset-based method is quite effective, as it shows how much stakeholders’ and investors’ profits will increase along with the company’s worth.
There are different methods to apply the asset-based approach. However, the frequently used ones focus on equity value and enterprise value. Both types of calculations require the company’s equity. In case the company doesn’t share equity with shareholders, the evaluator has to find alternative ways to run the formulas and equations.
ROI-Based Valuation Method
The ROI-based valuation method evaluates the return on investment ratio of the company’s ongoing projects. Based on these findings, the company makes a pitch to future buyers or investors, informing them about the profit they can expect from the business in the future. However, the ROI ratio is subjective to the industry and investment amount.
The income-based method is also known as the discounted cash flow (DCF) valuation approach. In this method, companies provide a project cash flow unit that is discounted or adjusted to match the present market value.
Moreover, investors or buyers use it to learn about past, present, and future profits. Then the findings are used to calculate whether the business will create desired income in the following years. This business valuation method is better suited to large enterprises than small businesses due to complicated calculations and formulas. However, even small companies can hire a business valuation company to determine their value through this method.
Capitalization of Earnings Method
Capitalization of earnings is a valuation method used to determine a company’s worth based on its projected profits and current performance. Compared to the DCF approach, this method is better suited to companies with a stable income source. As a result, the acquired results are applicable for the long term.
To use this method, the current net value, such as profits and cash flows, are divided by the capitalization rate. This shows how a company expects to perform in the upcoming years based on its real-time earnings and anticipated profits.
One limitation of this method is that the results are generalized for the long term based on predictions made on actual data. So, if the profits fluctuate in the future, it will void the entire estimated profit margin.
Multiples of Earnings Valuation Method
This valuation method multiplies the company’s current value with a specific number to display its future earnings. Most organizations use it to project their potential earnings. Due to this reason, it is also referred to as the time revenue method. The multiplier number varies according to industry, the market’s economic climate, and other factors, such as:
· Net income
· Adjusted income
· Cash flow
· Discretionary earnings
Therefore, it requires excellent skills to find the right multiplier to ensure the final value is accurate. The most significant advantage of this approach is that businesses can learn almost real market value if the analysis is conducted correctly. However, the major drawback is that the formula does not include the company’s growth. So, the findings may not be applicable in the long term.
Business valuation is a reliable way for organizations to learn their market value before finalizing sales. They can also use it to understand the issues in their business model, which allows them to fix the problems and improve profits and cash flow. There are some effective business valuation models, but each one focuses on different factors. Companies can apply one or a combination of multiple methods or use a professional business valuator to learn their fair market value.
You may also like: Eight Benefits of Utilizing Company Data
Image source: Depositphotos.com