Many people need to understand business valuations. We all know that increasing your business’ intrinsic value is essential to attracting customers, investors, or buyers. How can you improve this value? What makes your company truly valuable? Answering these questions can unlock your business’s value and make it a valuable commodity you could sell for profit.
What is a Business Valuation?
Business valuation is also called a company evaluation. It is the process used to determine the economic worth of an enterprise. During the valuation process, all aspects of a company are analyzed to determine the value of the business and its departments or units.
A company valuation is used to establish the fair value of an enterprise for many reasons. These include establishing ownership by partners, taxation and divorce proceedings.
Three Common Business Valuation Techniques
Take a look at three of the most common business valuation approaches:
- The Asset Technique
Asset valuation techniques assess the value of tangible assets and intangibles. The excess earnings method is used to evaluate intangibles. The latter method is seldom used to value sales.
- The Income Technique
The income technique is deemed the most important. The income technique focuses on the company’s cash flow or income and its risks. The discounted cash flow method values projected future cash flows, while the capitalized historical method evaluates past cash flows.
- The Market Technique
The technique uses comparable company data to calculate value. The guideline public company method analyses stock prices of similar companies for large publicly traded companies. The guideline M&A transaction method for smaller private companies examines sales of similar businesses in the same industry. Due to the limited availability of public information, this method can be complex.
Types of Business Valuation Methods
Business valuation is not a one-size-fits-all approach. Each investment banking valuation method offers a unique perspective on the value of a business. Take look at the most common approaches.
- Income Based Valuation
This method examines the financial health of a company and its prospects. It uses past financial statements, industry benchmarks, and growth trends to determine a company’s future cash flow potential. Under this method, discounted cash flow (DCF) is a widespread technique where future cash flows will be discounted to their current value to arrive at an estimated valuation.
- Earnings Multiplier
The earnings multiplier is used to determine the actual value of a business, as profits are a better indicator of financial success than revenue. The earnings multiplier compares future profits to cash flows that could have been invested at current interest rates over the same period. It adjusts current P/E to take into account current interest rates.
- Times Revenue Method
The method uses a multiplier on the revenue stream of a business to estimate its worth. The multiplier to use depends on the type of industry and the economic climate.
- Book Price
This method examines the shareholders’ equity on the company’s balance sheet (total assets minus total liabilities). It may not be a true reflection of the market value, particularly for intangibles.
- Liquidation Value
This method estimates the value if a company’s assets were sold and its debts settled immediately.
- Market-Based Valuation
This method uses the wisdom of crowds. It compares the company in question to other businesses of the same type recently sold within the same geographical area and industry. Market-based valuation is similar to how appraisers use comparable houses to estimate the fair market value of a home.
- Market Capitalization
It is the method most commonly used by publicly traded companies. The calculation is done by multiplying the company’s share price by its outstanding shares. It provides a snapshot of the value of a business but does not consider factors such as future growth or intangible assets.
Best Practices in Business Valuation
Here are some business valuation practices that are worth their weight and more.
- Keeping Financial Records Clean
The data used to value a business is as important as the valuation. It is essential to keep accurate and complete financial records. This not only simplifies your valuation process but can also increase the perceived value of your business.
- Choose the Best Valuation Method
When valuing a business, there are better approaches than a one-size-fits-all approach. Specific valuation methods can be more accurate than others depending on the type of business, its size and industry. You should choose the valuation method that is most appropriate for your business.
- Market Trends and Economic Conditions
When valuing a business, external factors are just as important as internal ones. Understanding the market and economic trends is a valuable tool to help you determine your business’s value.
- Engaging Professionals
We wouldn’t need professionals to do business valuation if it were easy. It is possible to do a self-evaluation, but a certified exit planning advisor can provide a more accurate and authoritative valuation. They ensure that all details are considered and that the valuation is more credible.
Conclusion
The valuation of a business is highly individual, and there are no universal methods. You must choose a strategy (or a combination of techniques) appropriate for your business. It is essential to consider the value of your company when making decisions.
