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Business Valuation: 6 Methods for Valuing a Company

Business Valuation: 6 Methods for Valuing a Company

What Is a Business Valuation?

Business valuation, also known as company valuation, is the process of determining the economic value of a business. During this process, all aspects of the business are analyzed to determine its overall worth, as well as the value of specific departments or units.

Valuations are commonly used during mergers and acquisitions, but they are also essential in many other contexts, such as taxation, establishing partner ownership, and even divorce proceedings. Many business owners seek professional business valuators for an objective and accurate estimate of their business’s value.


How Business Valuation Works

The valuation of a business involves determining its current worth using objective measures. This typically includes analyzing every facet of the business. Business valuation is particularly important when a company is preparing to sell part or all of its operations, engage in a merger, or when ownership stakes need to be established.

A comprehensive business valuation might include a review of the company’s:

  • Management
  • Capital structure
  • Future earnings prospects
  • Market value

Several tools and approaches can be used during the valuation, and these can vary depending on the evaluator, the business, and the industry. Common methods include financial statement analysis and discounted cash flow models.

Note: Estimating the fair value of a business is both an art and a science. Choosing the right method and appropriate inputs can be subjective or vary based on industry standards. Valuation can also involve intangible elements of a company’s value such as goodwill.


6 Methods of Business Valuation

A business can be valued in several ways, and each method provides a different perspective on a company’s worth. No single method is inherently more accurate than another; they all offer unique insights into the value of a company.

1. Market Capitalization

Market capitalization is the simplest method of business valuation. It is calculated by multiplying the company’s share price by the total number of outstanding shares.

For example, as of August 9, 2024, Microsoft Inc. traded at $406.02 per share. With 7.43 billion outstanding shares, Microsoft’s value would be calculated as:

$406.02 x 7.43 billion = approximately $3 trillion

Fact:
Market capitalization doesn’t account for debt a company owes that any acquiring company would have to pay off. It doesn’t account for cash on hand that would offset that debt. You would have to calculate the company’s enterprise value to determine these factors.

2. Times Revenue Method

In the times revenue method, a company’s stream of revenues over a certain period is applied to a multiplier, which is industry-specific. For example, a tech company may be valued at 3x revenue, while a service firm might be valued at 0.5x revenue, depending on the industry and economic environment.

3. Earnings Multiplier

The earnings multiplier provides a more accurate picture of a company’s value than the times revenue method. It accounts for the company’s future profits, adjusting them against the cash flow that could be earned if invested at the current interest rate. This method adjusts the P/E ratio to reflect current interest rates and is considered more reliable than revenue-based methods.

4. Discounted Cash Flow (DCF) Method

The DCF method is similar to the earnings multiplier but focuses on future cash flow projections. These projections are adjusted to reflect the current market value of the company. A key difference between the DCF and earnings multiplier methods is that the DCF accounts for inflation when calculating present value.

Also read: Understanding the Income Approach in Business Valuation

5. Book Value

Book value is determined by reviewing the shareholders’ equity as shown on the company’s balance sheet. It is calculated by subtracting the total liabilities from the total assets.

6. Liquidation Value

Liquidation value is the net cash that a business would receive if it sold off its assets and paid off its liabilities at the present moment.


What Is Market Capitalization?

Market capitalization (or market cap) represents the total market value of a company’s shares. It fluctuates as the company’s share price rises and falls and depends on the number of outstanding shares at any given time. It can be calculated by multiplying the current share price by the number of outstanding shares.


What Does Business Valuation Tell You?

A business valuation provides a dollar value for a company, usually derived from a combination of its assets, liabilities, earnings, future earnings potential, and market capitalization. This valuation is often used to determine the purchase price in a merger or acquisition, but it can also serve other purposes, such as tax assessments or investment decisions.

Also Read: How to do Valuation Analysis of any Company?


What Does Accredited in Business Valuation (ABV) Mean?

The Accredited in Business Valuation (ABV) designation is awarded to certified public accountants (CPAs) who specialize in business valuations. This certification is governed by the American Institute of Certified Public Accountants (AICPA). To obtain the ABV, candidates must pass an exam, complete an application process, and meet specific education and experience requirements.

In Canada, the equivalent designation is the Chartered Business Valuator (CBV), which is issued by the CBV Institute.


The Bottom Line

Business valuation is the process of determining a company’s objective economic value. Experts use various methods to analyze a company’s assets, liabilities, earnings, and future potential to derive a clear market value. Valuations are essential for mergers, acquisitions, investments, and taxation purposes, and the method used will depend on the unique context and goals of the valuation process.

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