Five methods are mainly used in business and companies valuation:Asset valuation – asset based approach – which consists in determining the value of equity, as a result of adjustments in the assets and liabilities of a company according to the criteria defined for its valuation (accounting, market, settlement, etc.).
Market assessment – market approach – Compares with competing companies.
Valuation by the current yield – the value is determined by the estimated future income in the date of the valuation. The dividend approach and the discounted cash flow approach are the most used perspectives.
Real options – real option approach – this technique takes into account the various types of decision that may generate different values and different cash flows in the future.
Legal – calculation of value is based on criteria defined by law, such as the code of commercial companies or the tax codes, for the determination of capital gains.
All methods of valuation of companies and businesses present advantages and disadvantages, and it is common to use several methods simultaneously, by weighing the value determined by each of them in order to determine the final trading interval.
The equity value method determines the company value with addition of all the assets, such as:
· Products in stock.
This method doesn’t take into account debts and financial obligations.
Advantages: shows the net value generated by the company until the moment of the valuation.
Disadvantages: doesn’t take into account the continuity of the company, its ability to acquire new contracts and customers or the increase of its sales.
Company profile: companies with low production capacity average, belonging to stagnant markets and with no prospect of improvement in medium / long term.
This method compares the current value of a business to other similar businesses, usually listed on the stock market. For this method to be as accurate as possible, compared companies must belong to the same sector. The product portfolio and the customer profile should also be similar.
Advantages: reflects the expectation of return forecasted by the market for a certain group of assets.
Disadvantages: competitive differentials, management styles and scale capacity of the valuated companies aren’t taken into account.
Company profile: companies with high concentration in the client portfolio and/or belonging to a low competition market.
This method analyzes the company’s ability to generate future wealth in a timeframe of 5 years minimum. Thus, the greater the forecast of the cash flow is, the greater will be the value of the company.
By using the discounted cash flow method, the company’s fix assets and history are taken into account, but the projections regarding the future of the company and its ability to generate forthcoming revenues are the most important.
One of the most relevant indicators used by this method to determine the value of a company is the so-called EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization.
Several other assumptions can be taken into account in the valuation of the company, such as:
• Customer portfolio;
• Distribution network;
• Quality of company management;
• Brand, patents and other assets.
Advantages: this method reflects the inherent risks of the company and its ability to generate long term cash.
Disadvantages: numerous independent assumptions are used, some of them presenting a high level of subjectivity.
Company profile: companies capable to generate positive cash flows, with a certain market maturity.
If you need help to value your business, use our Business Support Service
By Alberto Soares