Business Valuation

Valuation of the Company: How Much Is Your Business Worth?

Conducting an accurate business valuation is not as simple as it looks. How much any company is worth depends on various factors. Each factor tells the company’s potential for success.

However, estimating an accurate business worth is important because determining the Business worth helps the company to keep track of their Business.

This article help to understand why it is important to calculate the company worth and how organization can calculate the business valuation. It is also cover the factors that help to determine the company or Business worth.

What is the Valuation of the Company/Business?

Business valuation is also called company valuation. Valuation of the company helps to determine the worth of the Business and evaluate all aspects of the Business. 

Valuation of the company involves gathering and analysing business assets (tangible assets like cash in hand or cash at the bank, land and buildings, machinery and equipment) and liabilities (long-term debt, loans, deferred liabilities, taxes and payroll). Valuation of the company refers to forecasting the economic or intrinsic value of a company, a business, or a particular business unit.

What are the objective of the valuation of Company?

Understanding the purposes and importance of a valuation of the company will help to move forward to keep the records in a manner that can more accurately appraise the company. There are various objectives behind this valuation of the business or business valuation process to determine the fair value of a business. Some of the objectives are given below:-

Sale of Business

Suppose the company is planning to sell the entity or buy another. In that case, the best valuation of the company methods provide detailed information on past revenue, expense and profit data, a list of non-current assets (tangible & intangible assets), a debt structure and qualitative details of the company such as goodwill, patent, copywriting and employees. With the help of this information, an entity can estimate the profit of the company which will earn in upcoming years and help determine a fair price for the Business.

Dissolution of partnership

One or more partners might buy out the others, and a valuation of the company will help them dissolve the partnership easily. The partners can sell the Business to a third party, or if one person wants to quit the company, then the partner will serve the notice, and the other partner has the right to purchase the outgoing partner’s company’s share as an alternative to dissolution. So, for this purpose, the valuation of the business must be calculated to know the company’s outgoing partner share value.

Raising Funds

Raising funds either by floating shares in the stock exchange or getting funds from investors. In both cases, the valuation of the company plays an important role. In the case of raising funds from an investor, the investor will need to know the company’s current and future financial position. In the former case, the company valuation will be necessary for the people raising funds to decide the suitable competitive stock price and for the person who is buying the stocks to estimate future returns and make the correct call.

Taking a loan or debt

Banks and other lenders give loans to the company with the required collateral security called secured loans. Let’s understand this with an example; a business entity might take a loan to purchase new machinery to increase their production capacity by using other machines as collateral. For granting a loan to any business or company, potential lenders or banks want to know the company valuation to make an assessment.

Factors that help to determine the Company Worth

Valuation of the Company is not an easy task to do. Many factors and aspects of the company have to look at. Determining the company’s worth is the detailed analysis of internal and external factors of the Business.

As per my research, valuation experts look at the following factors when appraising a construction firm.

Past and historical data

One of the essential factors in valuing a company is its history and past performance. This includes how long the company has been in Business, how profitable it has been, and whether or not it has increased or decreased in value over time.

These factors can help give an idea of what a company might be worth.

Financial Performance

A company’s financial performance is always a key consideration for the valuation of the company. A profitable and growing business is likely more valuable than one struggling financially.

Income, earnings, and asset values are important factors to consider when assessing a business’s financial health.

Size of the company

The size of a business is another factor that affects its value. In general, the larger a company is, the more it is worth.

The company’s size is one factor in finding out its EBITDA multiple. The size of the company matter at the time of purchase or sale of the organization, an operating unit of the company, or stock. 

Future Growth

Each Business has a unique future outlook, which is impossible to predict with 100% accuracy. However, business analysts and investors will often try to estimate a business’s future profitability and growth potential to understand how much it may be worth today.

Thus, a company with a positive future outlook is likely worth more than one with a negative outlook.

Debt Structure

The company’s outstanding debt on its financial statements will impact its valuation. If the company has more debt, its shareholders have less equity value.

Additionally, high amounts of debt can limit a company’s ability to borrow additional money should it need to grow its Business.

Competition in the market

The competition level in an industry is another factor that affects a company’s value. A business in a highly competitive industry will be worth less than one that operates in a low-competition market.

This is because a business in a high-competition industry must spend more money on advertising and marketing to attract customers, which cuts its profits.

Business location

The location of a business is another factor that affects its value. A business located in a major city is worth more than a business located in a small town.

Businesses in major cities have more potential customers and can charge higher prices.

Ownership Structure

The ownership structure of a company is another important consideration when it comes to valuation. A private company have worth more than a publicly traded company. This is because private companies are not as exposed to the market and are not required to disclose all information. Consider the other thing is the type of ownership stake an owner has in a company.

For example, a company that is majority-owned by one person will be worth more than one that several people own.

What are the methods to calculate the valuation of the company?

There are different methods to calculate the business valuation or valuation of the company. Some of the most known and reliable methods are:

• Market-Based Approach
• Asset-Based Approach
• Income-Based Approach

Market-Based Approach

It is also called the relative valuation method. Using industry benchmarks, this approach includes comparing a company or organization to be valued with a similar industry business.

Comparing the net worth of the company with similar valuable assets based on essential metrics such as Price to earnings Ratio (P/E), Price to book ratio (P/B ratio), PEG ratio, EV/EBITDA, etc., to estimate the value of the share. The companies’ size differs, and ratios give a better idea about performance.

The following are the techniques for company valuation:-

• Market capitalization:- 

This is the most straightforward method where a company’s net worth is calculated in terms of outstanding shares value. The value is calculated by multiplying the share price of the company by the number of total o/s shares.

Formula = Market Price per share * Total Number of Outstanding Shares.

• Time Revenue Method

The time revenue method includes analysing the company’s revenue stream and estimating future revenue/income by applying a multiplier based on past data, industry benchmarks, and the economic environment.

• Price-to-Earnings Ratio (P/E)

The Price-to-Earnings ratio (P/E) technique is more accurate than the time revenue method. It is used to get a more precise reflection of the valuation of the company, as the earnings are appropriate indicators than the revenue stream to estimate its worth. This method helps to calculate the company’s net worth.

P/E Ratio = Earnings per share (EPS)/Market value per share​

• Price-to-Book ratio (P/B ratio)

The Price-to-Book ratio (P/BV) derives the company’s net-worth using the book or accounting value of the overall assets of the Business and the book value per share.

P/B Ratio = Book Value (BV) per Share/Market Price per Share

• EV/EBITDA

Enterprise value/EBITDA is a popular valuation method in the banking and finance industry and the used mainly by entities. The enterprise value refers to the sum of the value of equity, debt, and cash balance or bank balance.

Enterprise value = EV

EV = Market capitalization + overall debt − cash and cash equivalents (cash and bank balance)

EBITDA = Earnings before interest, taxes, depreciation, and amortization​

Asset-Based Approach

With the help of this approach, a business’s worth is based on the Net Asset Value (NAV)^[1] derived by subtracting debts and liabilities from the fair market value of everything a company owns, such as equipment and inventory.

NAV = (Assets – Liabilities) / Total number of outstanding shares

This provides a value that a business owner will require to establish an identical business. It can be a starting point or a way to determine the bottom-line value. However, a company’s true worth will probably be higher than the net value of its assets due to the nature of Business, a competitive edge, or goodwill.

Therefore, the asset-based approach is used to value a company with tangible assets because it is easier to calculate their fair value as compared to the intangible assets.

Income-Based Approach

Income-based valuation is also called discounted cash flow (DCF). In this approach, the company’s intrinsic value is calculated by discounting the future cash flows. The cost of the company’s capital assets is calculated by discounting the future cash flow.

Most analysts and financial researchers use this method to estimate the future profitability of the business and financial statement projections. This method involves calculating a company’s future cash flow based on past data, business dynamics, and industry and economic analysis. Then calculate discount forecasted cash flows to present value using estimated growth and the firm’s weighted average cost of capital (WACC).

Once the future cash flow is calculated, the investor can determine the stock’s value. This help to determine if the company is overvalue, undervalue, or at par.

Conclusion

Valuation of the company is important to calculate for many reasons, but measuring the business’s worth is not easy. Companies have to focus on the various aspects of the business. Many factors, such as historical data, financial performance, size of the business, business location, etc., help to determine the accurate value of the business. Various techniques are involved in determining the valuation of the company, such as income-based, market-based and asset-based approaches. If a company wants to calculate the valuation of the company, then these three techniques will be beneficial for them to get an accurate valuation.

Read Our Article: What is Business Valuation?