Brief on business valuation methods in India

Narendra Kumar

28 May, 2019

Business valuation method is nothing but a set of process and procedure which is used to determine the worth of the business. Well! At first, you may find it out very easy but going down the road it over’s one head. You can also read our article on what is business valuation

There is no way to find out what is business worth because the value of the business solely depends upon the person’s assumptions it is like different things to different people.  Furthermore, the uncertain economic conditions of the market affect what people believe a business is worth.

The recent study on Business valuation states that the circumstances in which a business is sold majorly affect the business value. There is a significant difference between a business which is backed by well-planned marketing to allure the buyer to buy and in no- time sale of business assets at auction. 

What is the reason for Business valuation

The reasons for business valuation are as follows-

• It determines the fair value of the business when going to sell the business due to any health issue, retirement, divorce or for family reasons.
• It expand the business i.e. Merger or acquisition or due to cash flow issues
• To calculate the debt or equity financing or the investor is willing to see the sufficient worth of the business.

In some cases, the shareholder also wishes to see the business valuation for future investment. Furthermore, the keen purpose of the business valuation is to know the actual value of the business in the current market by utilizing the objective measures and covering all the aspects of the business.

The Purpose of Business valuation

As mentioned earlier, the keen purpose of the business valuation is to know the actual value of the business in the current market.  A business valuation serves the purpose of analysis of company’s management, its future earnings, its capital structure or the market value of the assets.

Let’s us understand this with an example-

When there is scarcity in jobs, various other business buyers slip their hand in the market and increased the market and also the competition that results in increased and higher business selling price.

Business valuation Approaches or Business Valuation Method

The Business valuation approaches are often known as business valuation method. It is advisable that a business owner should not do their own business valuations this is like asking a sweet seller how tasty its sweets are. Neither the business owner nor the sweet seller has the necessary distance to step back and answer it wisely.

So, to ensure that you get and set the best value or price while selling the business, get a business done by the professional hand such as Chartered Business Valuator. A chartered business valuator is a person that evaluates the business value by using different valuation methods such as-

• Asset-Based Approach

This asset-based approach business valuation method totals ups of all the investment in the business. This asset-based valuation method can be done when a business is going concern or on a liquidation basis.

Going Concern- it lists the business’s net balance sheet value of its assets and subtracts the value of its liability. Asset Based = Assets – Liability

Liquidation basis- it calculates the net cash that would go to be earned if all assets were sold and liabilities are paid off. Basically, the balance left in hand after paying all the dues.

However, using the asset-based business valuation approach for the sole proprietorship business is a tough job. In other corporations, the assets are owned by the company and normally included in a sale of the business. The problem with the Asset-based approach for the sole proprietorship is that the assets exist in the name of the owner and separating assets from the owner’s hand is problematic.

Let us understand this with an example-

A Sole proprietor has a nursery care business, now he uses various nursery equipment for its personal use often times. Hence, it is difficult for a potential purchaser of the business to sort out which assets the owner intend to sell as part of the business.

• Earning Value Approach

The next one is the earning value approach, this business valuation method solely depends on the assumption that a business’s true value lies in its ability to produce wealth in the future. The often used earning value approach is the Capitalizing the Past Earning.

In this method, a valuator determines an unpredicted level of cash flow for the company using a company’s record of past few earning and also normalizes the cash flows by a capitalization factor. The capitalization factor is a mirror of what rate of return a purchaser would expect on the investment as well as determine the risk of the earning.

Discounted Future Earning is an alternate earning value approach to business valuation where instead of an average of past earning an average of the trend of the predicted future earning that is used and divided by the capitalization factor.

Any valuation of service-oriented sole proprietorship needs to involve an estimate of the percentage of business that might be lost under a change of ownership.

• Market Value Approaches

Market value approaches to the business valuation makes an effort to stand the value of the business by comparing it to its competitor business that has recently sold. But, with this business valuation approach, it will only show its colour if there are a sufficient number of similar businesses for comparison.

Undoubtedly, the earning value approach is the most acknowledged and popular business valuation method among the market.

Other Business Valuation Method 

• Market Capitalization – this is the most simple and easy method of business valuation. It is calculated by the multiplying the company’s share price by its total number of shares outstanding.
• Times Revenue Method – under this business valuation method, a stream of revenues generated over a certain period of time is applied to a multiplier that depends on the industry and economic environment.
• Earning Multiplier – the earning multiplier is used to get a more accurate picture of the real business valuation of a company since a company’s profits are a more reliable indicator of its financial success then sale revenue.
• Discounted Cash Flow- the method for this business valuation matched with earning multiplier. The method is based on some projections of the future cash flows that are adjusted to get the current market value of the company.
• Book Value-the value of the shareholder’s equity of a business as it appears in the balance sheet of the company.

So, Business valuation is also important for tax reporting like sale, purchase or gift of shares in the financial year. So, valuing the company is win situation in all circumstance. .