What is a Business Valuation?
A business valuation is a general process of determining the economic value of a whole business or company unit. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation and even divorce proceedings.
The valuation of a business is the process of determining the current worth of a business, using objective measures, and evaluating all aspects of the business.
A business valuation might include an analysis of the company’s management, its capital structure, its future earnings prospects, or the market value of its assets. The tools used for valuation can vary among evaluators, businesses, and industries.
The following is a list of the most common methods to value a business:
- Market Capitalization
Market capitalization is the simplest method of business valuation. It is calculated y multiplying the company’s share price by its total number of shares outstanding. For example, as of January 3, 2018, Microsoft Inc. traded at $86.35. With a total number of shares outstanding of 7.715 billion, the company could be valued at $86.35 x 7.715 billion = $666.19 billion.
- Times Revenue Method
Under the times revenue business valuation method, a stream of revenues generated over a certain period of time is applied to a multiplier which depends 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
Instead of the times revenue method, the earnings multiplier may be used to get a more accurate picture of the real value of a company since a company’s profits are a more reliable indicator of its financial success than sales revenue is. The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period of time. In other words, it adjusts the current P/E ratio to account for current interest rates.
- Discounted Cash Flow (DCF) Method
The DCF method of business evaluation is similar to the earnings multiplier. This method is based on projections of future cash flows, which are adjusted to get the current market value of the company. The main difference between the discounted cash flow method and the profit multiplier is that it takes inflation into consideration to calculate the present value.
- Book Value
This is the value of shareholders” equity of a business as shown on the balance sheet statement. The book value is derived by subtracting the total liabilities of a company from its total assets.
- Liquidation Value
Liquidation value is the net cash that a business will receive if its assets were liquidated and liabilities were paid off today.
This is by no means an exhaustive list of the business valuation methods in use today. Other methods include replacement value, breakup value, asset-based valuation and still many more.
Accreditation in Business Valuation
Estimating the fair value of a business is an art and a science. As you can see, there are several methods that can be used. Choosing the right one and then the appropriate input can be somewhat subjective. That’s why it is imperative to hire a professional that is accredited in business valuation. One of the world’s most accredited organizations is the CBV Institute. Business valuators like lawyers do not come cheap, but they are worth the money invested to maximize your asset division.