Valuations

We often hear the terms ‘valuation’ and net worth used to describe the monetary worth of individuals or businesses. But in business terms, what does this mean exactly?

Company valuation, also known as business valuation, is the process of assessing the total economic value of a business and its assets. Put simply, it is the value of the company’s assets, equity, and liabilities.

Why do we value companies?

We value companies for various reasons, some of them being:

· Determining the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation, etc.

· Tracking the performance of the company in the market as compared to others

· Measuring the company’s success and growth

Factors influencing the valuation of a company

Some factors that affect the valuation of a company are:

• Reputation and creditworthiness: Though this is an intangible factor, i.e., it cannot be quantified, the reputation and creditworthiness of the company play a major role in determining its valuation. An overwhelmingly positive reputation could significantly boost the value of your company, while a negative reputation could be detrimental to your prospects for selling your business.

• Staff and management: The employees and management of the company severely impact its output. Thus having an efficient and reliable team can help in increasing the value of the company.

• Growth prospects: The company’s future growth prospects help in determining the valuation. If the future looks bleak, it is likely that the valuation of the company is far less as compared to steady future growth.

• Earning history: The earning history of the company can help predict its future growth and trends. This will help in determining accurate valuations.

• Competitive advantages: The larger the competitive advantages one company has over the other, the better the valuation. This is because, with a better competitive edge, the growth and revenue of the company are much larger.

How do we calculate the valuation of a company?

There are several different that provide insight into a company’s financial standing. Let’s look at five of them.

Book Value

This is calculated using the company’s balance sheet. To calculate book value, start by subtracting the company’s liabilities from its assets to determine owners’ equity. Then exclude any intangible assets. The figure you’re left with represents the value of any company's tangible assets.

However, this method is highly unreliable as it does not consider several of the other factors.

Discounted Cash Flow (DCF) Method

This is usually used as the method to calculate the valuation.

Discounted cash flow analysis is the process of estimating the value of a company or investment based on the money, or cash flows, it’s expected to generate in the future.

The benefit of discounted cash flow analysis is that it reflects a company’s ability to generate liquid assets. However, the challenge of this type of valuation is that its accuracy relies on the terminal value, which can vary depending on the assumptions you make about future growth and discount rates.

Market Capitalisation

Market capitalization is the simplest method of business valuation. It is calculated by multiplying the company’s share price by its total number of shares outstanding.

One of the shortcomings of market capitalization is that it only accounts for the value of equity, while a combination of debt and equity finances most companies.

Times Revenue Method

The enterprise value is calculated by combining a company's debt and equity and then subtracting the amount of cash not used to fund business operations.

Here, a stream of revenues generated over a certain period of time is applied to a multiplier which depends on the industry and economic environment.

EBITDA

This acronym stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation.

This allows investors to ignore the effect of interest on loans, taxes paid and the depreciation or amortization calculated on assets, providing the actual success and revenue of the company.

- Siya Heda

Sources

• https://online.hbs.edu/blog/post/how-to-value-a-company

• https://www.investopedia.com/articles/fundamental-analysis/11/valuing-private-companies.asp#toc-raising-capital

• https://www.investopedia.com/terms/b/business-valuation.asp#toc-special-considerations-methods-of-valuation

• https://tremblylaw.com/6-key-factors-may-impact-business-valuation/

• https://www.mcmcapital.com/case-study/seven-factors-affecting-private-business-value/