Companies across the world tend to grow over a period to increase shareholder wealth. The growth is achieved either by market expansion, product diversification, merger and acquisition of the competitors. Companies may also have to raise capital to fund the expansion and achieve growth. The merger and acquisition are carried out based on many factors which mutually benefits the parties.
At the time of merger or acquisition, the acquisitor estimates the acquired company’s value by conducting a business valuation. Additionally, Business valuation is undertaken at the time of public listing of the company and company liquidation. Let’s learn more about business valuation.
Business Valuation
Business valuation is known as the process of determining the current commercial value of a whole business unit using objective measures by evaluating the business. It is used to ascertain the business’s fair market value for sale, establishing partner ownership and taxation purposes. Business valuation is carried out when a business is looking to sell the whole or a part of its business operations or looking forward to merging with a competitor or acquire a smaller company. Business Valuation is also very essential for any tax reporting to authorities.
The company management will often require professional business evaluators to estimate the value of the business. A business valuation process usually includes a thorough analysis of the company’s management, the company’s current capital structure, the present revenues and the future earnings prospects, and the market value of its saleable assets. In addition, professional business evaluators employ approaches to value a business that include a review of company financial statements, discounted cash flow models and peer to peer comparisons.
Methods Of Business Valuation
A business worth cannot be determined just by the annual EBITDA (earnings before tax, interest, depreciation and amortization) value but many other factors like cash flows, business risks, industry and debts etc. Moreover, the business valuation also depends on other aspects such as the purpose for the business valuation, the current level of information available, stage of business life cycle and others. Therefore, Business Valuation by a professional expert is highly advisable.
Many approaches can be used for business evaluation. The most common approaches are the Income-based, Market based and Asset-based approaches.
Asset-Based Approach
The asset-based methodology relies on the value of underlying net company assets to carry out the business valuation. Additionally, this approach totals up all the investments made by the company. Applying this methodology to a private limited or corporation is ideal as the assets and investments are included in a company sale. However, using the asset-based approach in the case of the sole proprietorship can prove complicated as the assets belong to the same individual and categorizing the assets from personal and business becomes a huge challenge to the valuators.
Income-Based Approach
The income-based approach (also generally known as the Discounted Cash Flow approach or DCF methodology) considers the revenue earnings capability of a company. Then, it converts the anticipated cash inflows into a present value. This method is a forward-looking approach and is based on the fact that the company’s real value lies in building wealth for the next foreseeable future. Considering this, the valuator ascertains the future cash flow by thoroughly examining the documents and assessing any future financial risk accordingly.
Market Value Approach
The market-based approach uses methods that compare the business with its peers to estimate the business value. It compares the value of the company business to other similar companies sold recently. The methodology can be applied only when there are enough competitors in the market.
Qualified and experienced professionals based on the clients’ requirements can help companies in business evaluations by using the correct valuations methodologies.
