Key Business Valuation Methods

When you are about to make a serious business decision, which can be merging, selling, or restructuring, business valuation is the tools that make it all possible. It guides you in unveiling the actual worth of your company based on your financial standing, business operations, and the market’s position. A business valuator starts by examining your financials and digs further into your market position, customer base, and forecasts expected future earnings to draw a clear picture of where your business stands today.

This is not merely done by a single approach but by several methods based on your business type, scale, and requirements. In the end, the aim is not just about adding the right price tag but about understanding the real worth and potential of a business built over the years and how it will flourish in the coming years. The following guide will shed light on some of the core types of business valuation methods and which suits your company’s requirements. But first, let’s generally understand what Business Valuation is.

Understanding Business Valuation

Business Valuation is a process through which a company can assess its true worth and assets based on future cash flows, financial statements, market position, and future potential. Business Valuations also emphasize non-tangible and non-financial assets like a company’s brand reputation, its loyal customer base, and intellectual properties. Business valuation is done for numerous reasons, such as:

• If the owner wants to buy or sell a business
• The company is looking for a merger or investment
• Authorities want to secure loans
• Businesses plan for growth or succession
• Companies want to integrate an employee share scheme
• To determine the internal performance examination.

Business valuation is done through several techniques and methods, each depend on the nature and stage of the business, as well as the intention behind the valuation. Different valuations can also be combined for a 360-degree view of a company’s worth. Business valuations are done by professionals who use robust tools, decide which method to choose for you, the best and perform a comprehensive business valuation.

Main Categories of Business Valuation Methods

Business Valuation Methods are mainly categorized into three types. These types are further divided into sub-categories that are used to serve different purposes with different requirements.

1.  Asset-Based Valuation Methods

This method focuses on a company’s net assets by computing the total assets and subtracting liabilities from them. This method is generally utilized by companies that have most of their assets physically, such as manufacturing, construction, and real estate businesses. The assets covered by this method are mostly cash, inventory, equipment, and property, while the liabilities include loans, unpaid taxes, unfulfilled payments, and accounts payable. This method is further classified into two sub-parts: the book value method and the adjusted net asset method.

a)    Book Value Method

The book value method determines a business’s worth through the values mentioned in its books. This method is convenient and easy to calculate, and is mostly used by stable asset-heavy companies. That being said, this method mostly overlooks intangible assets and future earning possibilities, and may not show the exact market position of the company.

b)    Adjusted Net Asset Method

The assets and liabilities are balanced in this market as per the ongoing market trends instead of just completely depending on the accounting books. Such as the business property’s worth may increase over time, and the investments can depreciate. So, at the end, the value is estimated keeping all these facts in mind. Although this process can be hectic and time-consuming and needs professional supervision, it is better than just relying on the book value, as it reflects true market conditions.

2.  Income-Based Valuation Methods

Income-based methods use an approximate value based on the company’s capability to generate revenues in the future. This method is mostly used by investors to know how fruitful their investments can be in the coming years. They are not very concerned with a company’s previous performance or revenues. This method is further divided into categories, which we will discuss below.

a)    Discounted Cash Flow (DCF) Method

This is one of the foremost methods used by businesses and investors to know future cash flows. This method uses a discount rate by forecasting future cash flows and discounting them back to the present value. DCF is generally very detail-oriented and analytical, hence suitable for growing companies. It considers all risks and the time value of money to project the market position of the company in the years ahead. However, due to a high rate of assumptions, it can be influenced by many factors and impact the valuation results. It demands skilled experts to perform complex DCF calculations.

b)    Capitalization of Earnings Method

Businesses with generally predictable earnings use the capitalization method to determine the profits the company is going to generate in the future. This method is based on assessment and expectations; hence, it is quite easy to grasp and calculate. It is mostly used by mature businesses with almost the same revenues year after year. Businesses with changing scales, evolving needs, and unexpected future revenues are not very appropriate to utilize this technique, as it highly relies on accurate findings or earnings.

c)    Seller’s Discretionary Earnings (SDE)

Mostly small businesses or owner-operated companies use the SDE method as it calculates the financial benefit available to the owner in the coming days. It covers the net profits, salary of the owner, unrequired expenses, and on-time expenses. As this model may not focus on the future growth possibilities, large corporations cannot depend on this method.

d)    EBITDA Multiple Method

EBTIDA means Earnings before Interest, Tax, Depreciation, and Amortization. Mostly a preferred method used for mergers and acquisitions. This method finds the value of a business by multiplying the industry-specific multiple by EBITDA. It is a quick tool to compare the value and is used very widely across businesses looking to acquire or merge. This, however, doesn’t ignore the capital expenses and certain company-linked risks.

3.  Market-Based Valuation Methods

When a business is compared in the market with other businesses of similar industry, sales, and size, they find out an estimated value. Real estate companies are valued based on their comparable sales. Its further classifications include:

a.    Comparable Company Analysis (CCA)

This method uses Price to Earnings (P/E), EBITDA, and Price to Sales method to compare the value of similar companies. It depicts the current market conditions and is useful for public companies mainly. On the other hand, any change in market conditions may affect the overall findings, making it not a very reliable valuation method.

b.    Precedent Transaction Method

By using the historical acquisition data of similar companies and examining purchase prices, trends, and transaction multiples, this method offers value based on real transactions. However, in many cases, past deals are not similar to current market situations, and every deal is unique, so it may help find an approximate figure but not an exact one.

Choosing the Right Valuation Method

To know which valuation suits your company the best, you must review several areas, which include:

• The Nature of Business: Like the asset-heavy companies, which use asset-based methods, but the service companies trust in income-based approaches
• Company’s Scale: Large corporations count on the DCF or market-based evaluations, but small businesses use SDE methods
• Industry Practices: Similar industries follow the same valuation practices. It is important to know which practices your similar companies are using for valuation.
• Availability of Data: The number of records you have and the financial documentation highly impact which valuation method you should pick.

SS&Co. Business Valuation Experts!

If you are not very sure about which method is worth it for your business assessment, you must engage with sscoksa.com. Business Valuation consultants. Our professional guidance ensures accuracy, and we work closely with you to help you understand the credibility of your business in the market, according to your industry and aims. Through our inch-perfect business assessment, you may plan business scaling, look for investment possibilities, and plan succession with complete confidence and clarity.