The method of assessing a company’s economic worth is known as business valuation. Many people are involved in a company’s value, including investors, creditors, sellers, and buyers.
It’s both an art and a science to calculate value correctly. We’ve mentioned six approaches for valuing a company below.
Basics of Business Valuation
In corporate finance, the subject of company valuation is frequently discussed. When a company wants to sell all or part of its operations, combine with another company, or buy another company, a business valuation is usually performed.
The method of assessing the current value of a company using objective criteria and analyzing all aspects of the business is known as business valuation.
An appraisal of the company’s management, capital structure, potential earnings prospects, or market value of its assets may be included in a business valuation.
Evaluators, companies, and markets all use different instruments for valuation. A analysis of financial statements, discounting cash flow models, and similar company comparisons are all common approaches to business valuation.
Tax reporting needs valuation as well. The Internal Revenue Service (IRS) mandates that a company’s fair market value be determined. Any tax-related events, such as the selling, acquisition, or gifting of a company’s shares, may be taxed based on their value.
Methods of Business Valuation
1. Times Revenue Method
A stream of revenues produced over a period of time is added to a multiplier that depends on the industry and economic environment in the times revenue business valuation process. A fintech firm, for example, would be valued at 3x revenue, while a health firm would be valued at 0.5x revenue.
2. Earnings Multiplier
The earnings multiplier, rather than the times revenue formula, may be used to provide a more accurate view of a company’s true worth, since profits are a more reliable measure of financial performance than sales revenue.
The earnings multiplier compares potential income to cash flow that could be spent for the same time span at the same interest rate. To put it another way, it changes the current P/E ratio to take current interest rates into account.
3. Market Capitalization
The most basic way of valuing a company is to use market capitalization. It’s determined by dividing the company’s share price by the total number of outstanding shares.
4. Discounted Cash Flow
The earnings multiplier is similar to the DCF system of business valuation. This approach focuses on potential cash flow forecasts that are tailored to determine the company’s current market value.
The key distinction between the discounted cash flow method and the benefit multiplier method is that the discounted cash flow method calculates the current value after taking inflation into account.
5. Book Value
The value of a company’s shareholders’ equity as seen on the balance sheet statement. A company’s book value is calculated by subtracting its total liabilities from its total assets.
6. Liquidation Value
The net cash that a company would gain if its assets were liquidated and its liabilities were paid off today is known as liquidation value.