Discover company valuation methods: The most widely used and up-to-date business valuation solutions today… To value a company and quickly estimate its worth, join KMC in exploring the latest, detailed company valuation methods shared below!
What is Company Valuation?
Company valuation is the process of estimating the value of a company or business for a specific purpose. This process is carried out using appropriate valuation methods.
Company valuation is typically performed by experienced professionals.
Company Valuation Methods
Currently, there are several methods for business valuation. Below, KMC will guide you through the most commonly applied company valuation methods.
1. Cost Approach Valuation
The cost approach valuation is a model that determines the value of a business by calculating the costs to create a similar business from scratch. Simply put, this involves estimating the cost to start the business operations from the ground up.
The valuation process is as follows:
- Step 1: List all potential startup costs, including the cost of acquiring tangible assets, recruitment and training expenses, establishing a customer base, and developing products or services.
- Step 2: Consider what costs could be reduced if you were to start the business again from scratch.
- Step 3: Subtract the expected savings from the total potential costs to determine the input cost valuation of the company.
Note:
This method provides a snapshot of your company’s value at a specific point in time. It does not provide insights into the business’s future value.
It is typically more suitable for very new startups rather than businesses with an established track record.
2. Discounted Cash Flow (DCF) Valuation Method
The discounted cash flow (DCF) method is a sophisticated technique used to value a business by focusing on determining the present value of future cash flows.
This method involves calculating how future cash flows will be valued at the present moment and from that, deriving the business’s value.
To calculate the present value of future cash flows, a discount rate is applied to account for risks such as unforeseen costs, expenses, and the time value of money.
Note:
- The time value of money indicates that one dollar earned today is worth more than one dollar earned tomorrow, as it has the potential to generate returns.
- This method is typically used for established businesses with stable and predictable cash flows.
The DCF method is often applied when seeking investors, as it helps forecast whether the business will generate a return on investment within the desired time frame.
To estimate this, projected cash flows are examined against debt repayment periods, and the discount rate is applied. If the calculated value exceeds the initial investment, it could be considered a viable investment option.
3. Comparable Market Multiples Method
This method estimates a company’s equity value based on the average market multiples of comparable companies. The comparable companies must meet the following criteria:
- Similar to the company being valued in terms of industry, business risks, financial risks, and financial indicators.
- Have information on the trading price of shares in the market either at the time of valuation or very close to it (no more than one year prior).
The company valuation formula is as follows:
Company Value = Market capitalization of common shares + Value of interest-bearing debt + Value of preferred equity (if any) + Non-controlling interests (if any) – Cash and cash equivalents, value of non-operating assets.
In which:
- The value of interest-bearing debt, preferred equity, non-controlling interests, cash, and cash equivalents is determined based on book value. In the absence of sufficient information, interest-bearing debt can be estimated based on loan and lease values.
- If the company has issued convertible securities or options, the appraiser will evaluate the conversion of these into common shares when determining the company’s market capitalization.
- EBITDA for comparable companies excludes income from cash and cash equivalents and income/expenses from non-operating assets.
4. Transaction Price Method
This method estimates a company’s equity value based on the price at which shares or equity interests were successfully traded in the market.
The equity value of the company is calculated using the average price per share from at least three successful transactions involving the transfer of shares or equity interests, which occurred closest to the valuation date.
5. Asset-Based Valuation Method
The asset-based valuation method is a way to estimate the value of a company by calculating the total value of the assets owned and utilized by the business.
We have:
Equity Value of the Company = Total Asset Value of the Company – Liabilities.
The total asset value of the company is the sum of the value of its tangible and primary assets, plus the value of its intangible assets.
How to Choose the Appropriate Company Valuation Method?
To choose the appropriate company valuation method for a business and its industry, the company needs to consider the following factors:
Type of Company
If a company has few assets, such as service-based companies, using the net asset valuation method may be irrelevant. Similarly, if the company’s value is primarily based on its brand or intellectual property, using the discounted cash flow (DCF) method may not be suitable.
Company Size
Larger companies tend to apply multiple valuation methods. Smaller companies with less available information typically use only a few methods.
Purpose of Valuation
The purpose of the valuation will also determine which method should be used. Some buyers focus only on the company’s tangible asset value, while others may be more interested in its potential for future cash flow generation.
Economic Environment
Regardless of the valuation method chosen, the economic environment in which the company operates must always be considered. However, even in favorable economic conditions, caution is advised when valuing a company, as every business cycle eventually comes to an end.
Considerations When Valuing a Company
Some valuation experts may assure that any method they choose will yield a figure close to the company’s intrinsic value. However, to successfully value a company, you should consider the following:
- Objectivity: Objectivity is critical in the valuation process. Valuations should not be influenced by personal opinions but must be based on data and factual information about the company.
- Simplicity: The valuation process should be simple enough to be understood and applied. Overloading with excessive details may obscure clarity and be counterproductive.
- Fairness: The valuation must be conducted fairly and transparently, so that anyone reviewing it can reach similar conclusions to the valuator based on the available information.
- Hire Professional Valuation Experts: Even if the company has the capability to conduct its own valuation, hiring an experienced third-party valuation expert is essential.
- Comprehensiveness: The valuation should not only focus on the company’s assets and cash flows but also consider the broader business environment and other internal and external factors.
It is clear that accurately and objectively valuing a company is crucial. It is highly recommended to hire a professional valuation expert with the appropriate expertise and experience to apply valuation methods impartially, provide accurate assessments, and offer a comprehensive and true representation of the company’s value.
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