While exploring companies for investment, you must have heard of business valuation to find the correct position of a company. If you are a business enthusiast, you should know that valuation is essential to project company growth and evaluate past performance. Numerous factors like market and industry performance affect business valuation, and different methods are used to determine the right value.
Are you in search of how to do business valuation of a company? You come up with the right blog; let’s dive into the details of business valuation and its key factors. Before that, let’s simplify valuation first.
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What’s Business Valuation Exactly?
For any company, business valuation refers to the process of determining economic value through analysing its financial performance & its factors and assets & liabilities. It reflects the true financial growth of the company in terms of sales, revenue, and asset generation. There are three approaches for how to find company valuation; income, market, and asset-based approach.
Business valuations are determined during mergers and acquisitions, resolving tax and legal disputes, and evaluating performance for investment. Investors often explore valuation to make strategic decisions on financing, understanding a business model, and exit strategies.
How To Find Company Valuation: Evaluate Three Approaches!
There is no precise one way to determine the business valuation for a company; you can explore three unique approaches that derive the exact estimations. Each approach follows a different formula and purpose to reach the valuation figure. While heading to find answers for how to do business valuation of a company, here are the popular approaches used:
Asset Based Approach
One of the easiest ways to find business valuation is by calculating net asset value (NAV). This approach determines the fair value of each depreciating asset and purchase prices for non-depreciating assets. It identifies the asset value and deducts liabilities to reach NAV, which is best for companies with high asset values. However, this approach fails to determine the company’s future earning potential and does not consider a few intangible assets. Here is the formula used:
Net Asset Value or NAV = Fair value of all company’s assets – sum of all the company’s outstanding liabilities
Income-Based Approach
This approach determines business valuation through projected future cash flows or profits. First, the company’s future earnings are determined, and its discounted present value is calculated using a discount rate, signifying risk associated with business operations. Companies with high prospect growth and the ability to generate future cash flows are best for income-based valuations. However, this approach is based on the assumption of future earnings that might miss uncertain factors. Here is the formula:
Discounted cash flow = 1st-year cash flow/(1+r)^1 + 2nd-year cash flow/(1+r)^2 + ……… + nth year cash flow/(1+r)^n
Market-Based Approach
This approach follows a comparison estimates to determine a company’s business valuation. It is also termed a relative valuation method and is commonly used for stock valuation. Different ratios comparing factors used for valuation, such as PE Ratio (Price to Earnings Ratio), PS Ratio (Price to Sales Ratio), PBV Ratio (Price to Book Value Ratio), and Earnings Before Interest, Tax, Depreciation and Amortisation. As companies are of different sizes and operate at distinct scales, this approach suits well-established companies with comparable businesses in the industry.
Process Followed For Business Valuation Of A Company
Here is the step-down process forwarding how to do a business valuation of a company:
Step 1: Valuation Preparations
Before proceeding with how to find company valuation, gather business plans, financial statements, and other legal documents. It helps capture the company’s financial performance, assets, and liabilities.
Step 2: Find The Right Valuation Method
The next step is to find the right method of business valuation depending on the company’s size, growth, and industry prospects. Selecting the appropriate valuation will help to provide accurate and correct estimates.
Step 3: Collection Of Data & Insights
After selecting the right business valuation, gathering relevant data insights, such as industry reports, financial statements, and market data, is crucial. Further, data analysis will help to assess financial growth and market position.
Step 4: Premium & Discounts
In a few cases, premiums or discounts must be applied to a company’s valuation, considering factors such as liquidity, marketability, or control. This helps to determine more accurate valuation figures.
Step 5: Crafting Valuation Reports
Once all the valuation processes are completed, the firm or professionals will finalise the valuation reports by projecting relevant data and analysis. The report is prepared based on specific methodology, assumption, and data.’
Factors Affecting Business Valuation Of Company
As we already get to know about how to do business valuation of a company, let’s move forward to key factors that affect business valuation:
Profitability & Revenue Growth
Any company with consistently high revenue and profitability will be more valued than those with weaker financial performance.
Assets & Liability
Both tangible and non-tangible assets contribute to the company valuation, while liability negatively impacts the estimation.
Cash Flow Structure
Any company with strong & consistent cash flows are generally valued higher than those with weak or volatile cash flows.
Market & Industry Conditions
A company in a strong and growing industry will be valued higher than one in a stagnant and declining market.
Business Valuation: A Growth Parameter!
In the blog, we summarise the process and factors for ‘How to do business valuation of a company’. The valuation strategically serves the purpose of sales, mergers and acquisitions, taxation, and legal disputes. However, you can still dig into valuation for knowledge and investing purposes.
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