The appraisal of your business is a crucial stage in the development of your professional career; as a result, it is advantageous to be aware of the methods that are employed to value your company. And if you’re looking to raise capital, your valuation is crucial. After all, it’s your company; therefore, the valuation and procedures used to calculate it should be familiar to you.
What exactly is a business valuation?
Simply put, business valuation is the process of determining the economic worth of your company.
Business analysis and valuation, as simple as they may appear, is a sophisticated exercise. The business valuation considers the assets, revenue estimates, share price, inventory, equipment, and cash assets of your firm, among other things; in short, it encompasses anything of economic value in your business.
What Is the need for a Business Valuation?
There are a few common reasons why business owners should assess the value of their company:
- When looking to sell your business;
- When looking for business funding or investors;
- When establishing partner ownership percentages;
- When adding shareholders;
- For divorce processes; and
- For certain tax considerations.
What are the Different Business Valuation Methods?
There are several methods for determining a company’s worth. In general, all of these methods yield a comprehensive and objective evaluation of the worth of your organization. The top seven business valuation methods are as follows:
1. Market Value Valuation
The market value business valuation approach is a subjective method of determining the worth of a firm. The first step in this strategy is to compare the value of your firm to similar businesses that have been sold.
This approach to business valuation is only practicable for companies that have access to detailed records on their competitors. However, it is not ideal for lone entrepreneurs because obtaining data about such competitive enterprises is difficult. Furthermore, utilizing the market value valuation method increases the likelihood of incorrect or imprecise computations.
As a result, firms should only use this strategy if they are confident in their ability to negotiate the final value if they are seeking investors or purchasers. Otherwise, another form of business appraisal should be utilized.
2. Asset-Based Valuation
In Malaysia, asset-based valuation is an effective business valuation strategy. It entails calculating the overall net asset value of the company and deducting the value of its liabilities. Businesses that intend to continue functioning should utilize the going-concern method to determine their worth.
In such a case, the value is determined based on the net cash that the owners will have in the event that the business is terminated.
It will help if you keep in mind that employing the liquation-based valuation approach indicates that the value of the company’s assets is likely to be reduced owing to market value disparities.
3. Discounted Cash Flow Analysis
Inflation-adjusted future cash flows are used to predict a value for the business in discounted cash flow analysis.
The logic underlying DCF Analysis is that free cash flows are what provides value to shareholders; hence FCF is the only statistic that matters.
The challenge then becomes how to anticipate discounted FCF several years in advance using a weighted average cost of capital (WACC).
Companies who are planning to close or are operating on the idea that the business will be completed in the near future, on the other hand, should use the liquidation value asset-based valuation. Even little changes in the growth rate, the perpetual growth rate, and the cost of capital can result in considerable valuation disparities, prompting criticism of the system.
4. Capitalization of Earnings Method
The capitalization of earnings method is a simple, back-of-the-envelope approach for assessing a company’s value, and it is utilized by DCF Analysis to compute the everlasting earnings.
The Capitalization of Earnings Method, often known as the Gordon Growth Model, requires that the business maintain a consistent level of growth and cost of capital.
To arrive at an approximation of a value, the numerator, usually, free cash flow is divided by the difference between the growth rate and discount rate, expressed as a fraction.
5. Revenue Multiplication
This method is similar to the EBITDA Multiplier method but for one difference: It can be utilized when EBITDA is either negative or unavailable due to various factors.
Again, while you may argue that it is only a benchmark, some might argue, with some justification, that a company’s total sales are the essential benchmark of all.
6. Book Value/Liquidation Value
Warren Buffett claims to have always considered the liquidation value—which is virtually the same as the book value—when determining whether or not companies are overvalued on the stock market.
The liquidation value is the net cash flow generated by a company if all of its liabilities were paid off and all of its assets were liquidated today. In some ways, calling this a company valuation approach is misleading because it only provides the worth of a portion of the business.
However, paraphrasing Warren Buffett helps you to assess the margin of error in a valuation. According to the rationale, even if everything goes wrong in management and the company’s sales plummet substantially after the acquisition, it can always rely on the liquidation value.
You may also like to read this article: A Complete Guide To Understand Business Valuation Market Value Approach
7. Real Option Analysis
Real options analysts see companies as nothing more than a collection of real options: the option to invest in opportunities, the option to use excess capacity, the option to hire more salespeople, and so on. Bringing these alternatives together is the foundation of meaningful options analysis for valuation.
This is useful for enterprises with unknown futures, typically those that aren’t currently income-producing, such as startups and mineral exploration firms.
It is the most sophisticated valuation methodology on our list, but its supporters include McKinsey and some of the world’s most famous business schools.
Wrapping it up
Business valuation is complex—especially when you examine the various ways available to appraise your company and estimate its economic worth.
Overall, it’s safe to state that one strategy isn’t necessarily superior to another; rather, the best estimate of your firm will most likely arise from integrating numerous business valuation methodologies. This being said, if you require a small business valuation, your best bet will be to employ a professional appraiser—as previously noted, this expert will be able to provide the most thorough and objective evaluation of your business.