5 minutes read
What is Business Valuation
Determining the value of a business is a non-linear and non-mechanical process that hinges a lot on the insight and foresight on circumstances surrounding the valuation. Businesses seek valuation services to be able to negotiate during mergers and acquisitions competitively to:
- preserve the value of the business
- prepare for unforeseen circumstances
- avoid buyer-seller disputes
A business is valued by the market opportunities that it has or the market value of the assets (tangible and intangible) it has accumulated or based on its financial performance and sustainability of its earnings potential and profitability.
It should be noted that valuation of a business is subjective science. Business Valuation is essentially the price that a buyer and seller agree to in a good faith negotiation, which may be a merger or acquisition transaction, dilution of owner’s equity, or a buy-out.
Why is Business Valuation Important
There are many reasons that necessitate a business valuation.
Ideally, a business owner should start valuing his or her business right from the start-up stage. Valuation matters to entrepreneurs because it determines the share of the company they have to give away to an investor in exchange for money.
Other reasons may include an internal restructuring, an acquisition or a share swap, an incoming external investment, separation of partners, tax and insurance planning, or succession and retirement planning.
No matter which stages one’s business is at, in terms of revenue, product, number of employees, partnerships, branding — valuation gives the business owner a sense of direction and enables the owner to envisage the future. With the evaluation information, business owners can deploy strategies to fuel growth, possibly by attracting investment in return of diluting some equity.
How Business Valuation is Done
Every business would require a different perspective on its valuation, depending on the stage of the business’s life cycle and its desired outcome. For example, if one is looking for an exit, what happened in the past and what is happening in the present would drive the valuation estimate. Whereas if one is looking for investment, future growth potential takes utmost importance.
Insiders agree that valuation is an art form. There is thus no definitive right or wrong way to arrive at a number.
You should always be mindful of the following when calculating what your business is worth:
- Always factor in the non-financials;
- Subtract the personal expenses and recast the financial statements;
- Apply a method to your madness and use multiple methodologies to cross-check valuations;
- Enlist a professional so that all emotions are checked at the door
What are the Three Methods of Valuation?
In terms of valuation methodologies, there are three widely accepted approaches that experts adopt:
- Income Approach which transforms profits or cash flow into estimates of value by way of multiples, capitalization rates and discount rates
- Market Approach which analyses the recent sales of comparable businesses
- Rules of Thumb approach which includes using simple and powerful valuation methods regularly adhered to by market participants
Other Methods of Valuation
While there are many popular methodologies to conduct a valuation, the two most popular ones are – the Discounted Cash Flow method (DCF), and the Comparative Ratios method.
Discounted Cash Flow (DCF)
This popular method – while tricky to get right – determines a company’s current value according to its estimated future cash flows. It is used to estimate the attractiveness of an investment opportunity.
According to Investopedia, “DCF analysis uses future free cash flow projections and discounts them to arrive at a present value, which is then used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.”
In this method, there are two types of ratios that an acquiring company uses to make a purchase offer that is a multiple of the earnings of the target company. These include:
- Price-Earnings Ratio (P/E Ratio) – looking at the P/E for all the stocks within the same industry group
- Enterprise-Value-to-Sales Ratio (EV/Sales) – looking at the price-to-sales ratio of other companies in the industry
InCorp Can Help You With Your Business Valuation
At InCorp, we adopt international Valuation Standards to determine the business value in the current market. For comprehensive business valuations, we consider several factors, amongst others, the nature of the business, history of the company, the value of its stocks, market base, brand value, competition, market prospects and economic condition. Our Chartered Valuers have vast experience and diverse sector knowledge to render reliable valuation service that can help you to identify opportunities, secure positions and gain a long-term advantage. Our valuation reports adopt different valuation methods as cross-checks and also include scenario analysis that help business owners, entrepreneurs and investors assess the risks involved in transactions and make informed decisions.
We provide the following valuation services:
Financial Instruments & Employee Share Purchase Plans
Transaction Valuation & Business Planning
Purchase price allocations
Valuation of Intellectual Property such as Patents and Trademarks
Goodwill Impairment Testing
Litigation and Dispute Resolution
Contact our Team:
Get a professional perspective on your business valuation
With InCorp’s team of expert advisors, we ensure your business worth is measured right.