Business Valuation Methods June 6, 2011Posted by Ian Cheng in Funding.
Business Valuation has become an intrinsic part of the corporate landscape. The corporate landscape has witnessed dynamic changes in the recent years as mergers and acquisitions, corporate restructurings, and share repurchases are happening in record numbers, both in the United Statesand abroad. At the core of the dynamics of all these activities stands some notion of valuation. The valuation methods are not only necessary for accounting purposes but they also serve as roadmaps for the angel investors, venture capitalists and corporate acquirers in order to know the true value of a company’s assets.
Although there are numerous individual valuation techniques, these are categorized into four standard business valuation approaches applying standard formulas:
The Asset Approach is based on the premise that it is generally possible to liquidate the property, plant and equipment (PP&E) assets of a company, and after paying off the company’s liabilities the net proceeds would accrue to the equity of the company. Valuation of assets based on liquidity does not yield better results if the fair market value of assets is in excess of value of its assets on a liquidated basis.
Discounted cash flow method
This valuation method based on free cash flow is considered a strong tool because it concentrates on cash generation potential of a business. This valuation method uses the future free cash flow of the company (meeting all the liabilities) discounted by the firm’s weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity), plus a risk factor measured by beta. Since risks are not always easy to determine precisely, Beta uses historic data to measure the sensitivity of the company’s cash flow, for example, through business cycles.
This valuation method is applicable for quoted companies only. The market value is determined by multiplying the quoted share price of the company by the number of issued shares. This valuation reflects the price that the market at a point in time is prepared to pay for the shares. This valuation method broadly takes into account the investors?perceptions about the performance of the company and the management’s capabilities to deliver a return on their investments.
Price Earnings Multiple Valuation
The price-earnings ration (P/E) is simply the price of a company’s share of common stock in the public market divided by its earnings per share. By multiplying this P/E multiple by the net income, the value for the business could be determined. This valuation method provides a benchmark business valuation as the non-listed companies wishing to use this method; a comparable quoted company/sector should be used.
Financial experts believe that business valuations using any method should not be too high or too low because that could be costly, resulting in either overpayment or lost opportunities. The firms that face important investment, acquisition, or growth decisions, particularly in a rapidly changing competitive environment, effective management requires an understanding of value creation and a command over valuation analysis.