Trying to figure out a company’s fair market value can be a challenging feat. However, there are many reasons why this may be necessary. As a business owner, you may be looking to merge with another company, considering a partnership, or you may simply want to see how your business is performing compared to your competitors. Consequently, how do you calculate the worth of your business? Here are a few options for gauging how your company is performing.
Having a complete understanding of creating the ideal business valuation is based on experience and working with a company you can trust. Yet having a basic understanding of the concept is important for any business owner.
What Is a Business Valuation?
The term “business valuation” refers to the process of assigning a monetary value to an entire company or division thereof. Business valuation is essential, whether for tax purposes, dividing assets in a divorce, settling a company dispute, or determining a sale price. To get a fair assessment of the company’s worth, many entrepreneurs consult with experienced business evaluators.
How To Valuate a Business
The process of determining a company’s valuation can be done in a number of different ways. We discuss several of these techniques in more detail below, this doesn’t paint the complete picture, but can help you with understanding some essential concepts.
One of the easiest ways to evaluate a publicly listed company’s worth is by its market capitalization. To determine this, we simply multiply the current share price by the total number of outstanding shares.
However, even though most businesses use a mix of debt and equity financing, market capitalization solely considers the value of the equity. Debt in this context represents financial backing for the company’s growth from sources like banks and investors. Interest is added to these debts until they are repaid in full. A company’s equity is its stockholders’ claim to a portion of the business’s future earnings.
Discounted Cash Flows
Discounted cash flows are another approach to calculating a company’s worth. When it comes to business valuation, this method is frequently regarded as the benchmark. It considers the money it is expected to earn in the future. With a discount rate and a timeframe in mind, a discounted cash flow analysis determines the present value of expected cash flows in the future.
Discounted cash flow analysis has the advantage of reflecting a company’s capacity for the generation of liquid assets. However, the problem with this kind of valuation is that it depends on the future value, which varies with growth and discount rate assumptions.
Derived from a company’s balance sheet, the book value is one of the simplest approaches to determining a company’s worth. However, this approach is extremely unreliable because of its lack of complexity.
The book value is calculated by deducting the liabilities of a business from its assets to get the shareholders’ equity. Then take out the value of any intangibles. What’s left is the worth of the company’s tangible assets. The value of the company, however, is likely to be significantly more than the sum of its net assets.
Times Revenue Method
The times revenue approach estimates a company’s value by multiplying its expected future cash flows by a factor that varies according to the economic climate and industry. A tech firm, for instance, would be valued at three times its annual revenue, whereas a service company might be worth half that much.
Since a business’s profits are a more dependable predictor of its financial performance than sales revenue, the earnings multiplier can be used as an alternative to the times revenue approach to painting a clearer picture of a company’s fair value. With the earnings multiplier, projected profits are readjusted to account for the interest that could be generated on the same amount of funds invested over the same time frame. Simply put, it corrects the current P/E ratio to reflect the market interest rate.
Think Outside of Financial Formulas
Business valuation is challenging because of its inherent complexity. If you want an accurate representation of the company’s worth, you need more than numbers. Studying the company’s financials, sales trends, supplier and customer base, and other factors is essential for a reasonable valuation. When calculating its worth, don’t forget to factor in your company’s location. Consider the strategic value it could have to a potential buyer if the two companies have complementary business models.
For this reason, an impartial appraisal from a professional business valuator is recommended. Their report can be used to find any underlying financial problems and set a solid foundation for negotiation.
The Bottom Line
A valuation is a great way to gauge the company’s financial standing and prospects if you own a business or are looking to purchase one. By getting a business valuation done by a reputable firm, you can accurately determine the economic value of your company.
The above methods are just a glimpse of what it means to get a business valuation done. Contact us at Albion International Services to discuss your goals and the reason for your business valuation. Our expert team has 30+ years of experience in M&A, Business Valuations and helping sellers get the best deal possible.