One needs good financial skill for understanding business valuation for any leaders who wants to achieve success in today’s dynamic scenario. So what is business valuation, knowing it and its methods becomes extremely important for anyone who is planning to buy, sell, or simply grow business. For navigating financial landscape with confidence and for strategic planning understanding business valuation is the key.
What is business valuation?
A business valuation refers to a process of determining the current value of a company, investment or an asset. Here all areas of business are analysed during the valuation process to solidify the worth and value of al it departments.
There are a number of common valuation techniques, as described below. Analysts who want to place a value on an asset normally look at the prospective future earning potential of that company or asset.
Importance of business valuation process
A business valuation is often used during the process of negotiating the merger or acquisition of one company by another but it might be used in other situations as well. Owners will often turn to professional business evaluators for an objective estimate of the value of the business.
Valuing a business is to know the current worth of a business using objective measures. This process evaluates all aspects of the business. Business valuation is typically conducted when a company is looking to sell all or a portion of its operations. It’s also used during a merger or acquisition of one company by another as well as when establishing partner ownership, for taxation, and even as a part of divorce proceedings.
Reasons for performing a business valuation
Valuation is an important exercise since it can help identify mispriced securities or determine what projects a company should invest. Some of the main reasons for performing a valuation are listed below.
Fundraising or investment
For any startup business, establishing exact valuation figures to find investor is necessary for calculating equity market value before funding rounds.
Business buy or sell
Buyers and sellers will normally have a difference in the value of a business. Both parties would benefit from a valuation when making their ultimate decision on whether to buy or sell and at what price.
. If you are in a partnership or LLC, a buy/sell agreement between principals can help to avoid future disputes. A mutually agreed upon value is the starting point for an agreement that is acceptable to all parties.
Also, it’s a great idea to if one is planning to sell business to set a base line value for the business and develop a strategy to improve the profitability to increase the value as an exit strategy.
Shareholder or Partnership Disputes
If an owner decides they want out of the partnership, an independent business valuation is necessary to arrive at a fair settlement of ownership interest.
Mergers and Acquisitions
If your growth strategy includes buying or merging with another company, a business valuation will help you determine if the price you are being asked to pay is a fair one.
Strategic planning
To increase any company’s net worth it becomes essential to have a valuation based on future profitability.
Methods of business valuation
There are many ways a company’s valuation can be done and each method can provide different view. Let’s delve into some of the popular methods used for business valuation.
Market Capitalization
The easiest method for business valuation is market capitalization. This method calculates the business valuation by multiplying the company’s share price to its total number of shares outstanding.
Times Revenue Method
This method uses stream of revenues generated over a certain period of time to a multiplier depending on the industry and economic environment. For example, a tech company may be valued at 3x revenue while a service firm may be valued at 0.5x revenue.
Earnings Multiplier
The earnings multiplier is a more accurate method for business valuation as for any business it’s profits are a true indicator of the financial success than sales revenue. This method adjusts future profits against cash flow that could be invested at the current interest rate over the same period. It adjusts the current P/E ratio to account for current interest rates.
Discounted Cash Flow (DCF) Method
This method of business valuation is similar to the earnings multiplier based on projections of future cash flows and adjusted to get the current market value of the company. This method also considers inflation in calculating the present value.
Book Value
Book value is derived by deducting total liabilities of a business from its total assets.
Liquidation Value
Liquidation value is the net cash any business receives when its assets are liquidated and liabilities paid off.
A company valuation process is the practice of calculating an objective dollar value for a business. Assets and liabilities, cash flows, earnings, or other metrics are used to determine the business value. Valuing a business is many a times part of a merger or acquisition too. Business valuation is also used by investors or for tax purposes. There are various methods in which a business valuation can be done.
