Valuation

Definition of business valuation

A business valuation is a general procedure of determining the economic value or worth of a company. In some cases, it is necessary to perform a business valuation to establish the fair market value of a business for purposes such as sales, partnership agreements, or tax assessments.

Business owners will often turn to professional appraisers to help them understand what factors impact the value of their business. It is important to identify which drivers influence the worth of an organization as most investors rely on businesses' valuation when buying stocks, bonds, and other financial assets.

What an appraisal report looks like

An appraisal report typically contains three primary sections: overview, analysis, and conclusion.

• Overview: This section provides background information about the business being valued, including industry trends, financial performance, and competitive landscape.
• Analysis: Here, the business appraiser analyzes key metrics like sales volume, profit margins, capital investment, and growth potential. They may also evaluate intangible assets like brand equity, patents, trademarks, customer relationships, and employee training programs.
• Conclusion: Finally, the valuation professional determines the overall value of the business based on their findings.

The foundations of business valuation

Business valuations are often required when companies look to sell all or part of their operations, or when companies want to buy out another firm. In both cases, it is important to determine the actual value of the company being acquired or sold. This requires a thorough assessment of the company's financial health, including its balance sheet, income statement, cash flows, and intangible assets.

A business valuation process is performed by comparing the company under consideration to other organizations in the industry. Many factors must be considered when conducting a valuation, such as the size of the company, the type of products or services offered, the competitive environment, and the overall economic climate.

An evaluation of a company's management, its capital structure, and its growth potential is also necessary. Finally, a review of the company's physical assets and liabilities is needed to complete its valuation.

The most common approaches to business valuation

There are many valuation methodologies used to determine the worth of a company. The choice of method depends on the type of business, its size and complexity, and the purpose for which it is being valued.

A business may be valued as a whole or in parts (e.g., by segmenting the company into product lines). Valuation methods can also vary depending on whether they are used for financial reporting purposes or for determining the fair market value of a company.

A few of the most common approaches include:

Market capitalization

In this business valuation approach, the worth of a company is determined by multiplying the current price per share times the number of shares outstanding. However, this calculation assumes that the company has no debt. If there is any debt, then the market cap should be adjusted accordingly.

Discounted cash flow analysis

This approach involves estimating future earnings and then discounting those estimates back to present-day values using a discount rate. The resulting figure represents the "present value" of future profits.

Book value

In Finance, book value is the historical cost of a company's assets minus depreciation, which serves as an indicator of financial health. It uses the information from the balance sheet statement to calculate the price per share that shareholders could receive if they were to sell their shares.

It is calculated by subtracting a company’s liabilities from its assets to determine owners’ equity.

Asset-based valuation

The asset-based valuation model (ABVM) uses the value of its business assets to determine a company's worth and then adds the firm's intangible assets such as brand equity, customer relationships, and patents.  

Liquidation value

This is the amount of money a company will get back if it sells off everything it owns. It is typically higher than the intrinsic value because it includes the value of the company's tangible assets.

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In addition, some other business valuation methods in use today include the market multiple, enterprise value, times revenue method, replacement value, breakup value, and earnings valuation, to name a few.