How is a Business Valuated?

There are several business valuation methods, and according to the purpose of the business valuation, the correct method is finalized. Choosing a suitable method is the first important step of business valuation. For that, identification of purpose is necessary. For identification, some parameters are fulfilled.

What is the need for a business valuation?

The business valuation is necessary for various reasons- for presenting before the investors, as a document in a lawsuit, inheritance, calculating the sale made by the business, exit of a partner, making public offers, or authentication of the net worth.

What are the approaches for a business valuation?

Primarily there are three approaches for the business valuation:

1. Market-Based Approach: Under a market-based approach, it is necessary to identify a firm under the same industry with whom the concerned company is compared based on the suitable multiples:

• The earnings of the company post-tax deduction are multiplied to calculate an estimation of the value of equity. This multiplier is widely used, however as the profit is calculated after deducting the tax, it involves several accounting adjustments, therefore distorted.
• Compared to the multiplier of the earnings, the sales estimation is distorted and easily calculated, and the capital structure does not affect it much. It is preferable to small firms, which don’t make huge profits or continuous profits.
• The book value is multiple applied to the account value of the net assets of the company.
• Earning Before Interest, Taxes, Depreciation, and Amortisation is highly preferred in the evaluation process of a business, as it removes the distortions relevant to unstable tax rates, capital structure, and non-operating incomes. Therefore, EBITDA is more reliable.

2. Asset-Based Approach:

• The easiest approach is Net Asset Value by calculating the fair value of the business assets and deducting the external liabilities. In this approach, the determination of the fair value is based on the acquisition value and the recorded value.
• The actual value of the business may be higher than the fair valuation of the company's assets as the unpaid debts form a part of the value of the business.

3. Income-Based Approach:

• The discounted cash flow is one of the popular methods of business valuation, which involves calculating the present value of the business based on the future flow of cash.
• The discount of the present value is done using the cost of the capital of the company. The shareholders' cash flow before the debt obligation to the firm is used as an input in this method. Therefore, it results in equity value.

How to pick a method?

The choice of method is essential. Therefore, while choosing the method, the factors that influence the choice of the method are as follows:

• Data that is available
• methods that are suitable for the purpose, industry, and the business kind
• Details are required.

Conclusion

There are multiple methods of value estimation. The final value is divided into the average for the purpose. The only rule applicable at the time of valuation is that to calculate the valuation, it is necessary to use common sense and intuition to understand the requirement of the inputs so that it passes the acceptability test at the time of issuing the valuation report.