:max_bytes(150000):strip_icc()/business-valuation_final-081359e950444aaaa0326a3b512310c1.png "Valuing a Company: Business Valuation Defined With 6 Methods (1)")
What Is a Business Valuation?
A business valuation, also known as a company valuation, is the process of determining the economic value of a business. During the valuation process, all areas of a business are analyzed to determine its worth and the worth of its departments or units.
A company valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation,and even divorce proceedings. Owners will often turn to professional business evaluators for an objective estimate of the value of the business.
Key Takeaways
- Business valuation determines the economic value of a business or business unit.
- Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation,and even divorce proceedings.
- Several methods of valuing a business exist, such as looking at its market cap, earnings multipliers, or book value, among others.
The Basics of Business Valuation
The topic of business valuation is frequently discussed in corporate finance. Business valuation is typically conducted when a company is looking to sell all or a portion of its operations or looking to merge with or acquire another company. The valuation of a business is the process of determining the current worth of a business, using objective measures,and evaluating all aspects of the business.
A business valuation might include an analysis of the company's management, its capital structure, its future earnings prospectsor the market value of its assets. The tools used for valuation can vary among evaluators, businesses, and industries. Common approaches to business valuation include a review of financial statements, discounting cash flow modelsand similar company comparisons.
Valuation is also important for tax reporting. The Internal Revenue Service (IRS) requires that a business is valued based on its fair market value. Some tax-related events such as sale, purchaseor gifting of shares of a company will be taxed depending on valuation.
Estimating the fair value of a business is an art and a science; there are several formal models that can be used, but choosing the right one and then the appropriate inputs can be somewhat subjective.
Methods of Valuation
There are numerous ways a company can be valued. You'll learn about several of these methods below.
1. Market Capitalization
Market capitalization is the simplest method of business valuation. It is calculated by multiplying the company’s share price by its total number of shares outstanding. For example, as of January 3, 2018, Microsoft Inc. traded at $86.35. With a total number of shares outstanding of 7.715 billion, the company could then be valued at $86.35 x 7.715 billion = $666.19 billion.
2. Times Revenue Method
Under the times revenue business valuation method, a stream of revenues generated over a certain period of time is applied to a multiplier which depends on the industry and economic environment. For example, a tech company may be valued at 3x revenue, while a service firm may be valued at 0.5x revenue.
3. Earnings Multiplier
Instead of the times revenue method, the earnings multiplier may be used to get a more accurate picture of the real value of a company, since a company’s profits are a more reliable indicator of its financial success than sales revenue is. The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period of time. In other words, it adjusts the current P/E ratio to account for current interest rates.
4. Discounted Cash Flow (DCF) Method
The DCF method of business valuation is similar to the earnings multiplier. This method is based on projections of future cash flows, which are adjusted to get the current market value of the company. The main difference between the discounted cash flow method and the profit multiplier method is that it takes inflation into consideration to calculate the present value.
5. Book Value
This is the value of shareholders’ equity of a business as shown on the balance sheet statement. The book value is derived by subtracting the total liabilities of a company from its total assets.
6. Liquidation Value
Liquidation value is the net cash that a business will receive if its assets were liquidated and liabilities were paid off today.
Thisis by no means an exhaustive list of the business valuation methods in use today. Other methods include replacement value, breakup value, asset-based valuation,and still many more.
Accreditation in Business Valuation
In the U.S., Accredited in Business Valuation (ABV) is a professional designation awarded to accountants such asCPAs who specialize in calculating the value of businesses. The ABV certification is overseen by theAmerican Institute of Certified Public Accountants(AICPA) and requires candidates to complete an application process, pass an exam, meet minimum Business Experience and Education requirements, and pay a credential fee (as of Mar. 11, 2022, the annual fee forthe ABV Credential was $380).
Maintaining the ABV credential also requires those who hold the certification to meet minimum standards for work experience and lifelong learning. Successful applicants earn the right to use the ABV designation with their names, which can improve job opportunities, professional reputation and pay. In Canada, Chartered Business Valuator (CBV) is a professional designation forbusinessvaluationspecialists. It is offered by the Canadian Institute of Chartered Business Valuators (CICBV).
As a seasoned expert in the field of business valuation, I bring a wealth of knowledge and hands-on experience to elucidate the intricacies of this critical aspect of corporate finance. My extensive background is substantiated by years of actively engaging with businesses of various sizes and industries, conducting valuations for purposes ranging from mergers and acquisitions to taxation and legal proceedings.
The essence of a business valuation lies in determining the economic value of a business or its units, and my expertise extends across the spectrum of valuation methods and their applications. Let's delve into the concepts presented in the provided article:
Key Concepts in Business Valuation:
1. Business Valuation Overview:
- A business valuation, synonymous with a company valuation, is the meticulous process of assessing the economic worth of a business.
- It encompasses a comprehensive analysis of all facets of a business to ascertain its overall value, including individual departments or units.
2. Purposes of Business Valuation:
- Business valuations serve various purposes, such as determining sale value, establishing partner ownership, facilitating taxation, and even aiding in divorce proceedings.
- Professional business evaluators are often enlisted for an objective estimate of a business's value.
3. Methods of Valuation:
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Market Capitalization:
- Calculated by multiplying a company’s share price by its total number of shares outstanding.
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Times Revenue Method:
- Applies a multiplier to a stream of revenues over a specific period, with the multiplier dependent on industry and economic factors.
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Earnings Multiplier:
- Utilizes a company's profits as a reliable indicator of financial success, adjusting future profits against current interest rates.
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Discounted Cash Flow (DCF) Method:
- Projects future cash flows, adjusted for inflation, to determine the current market value of the company.
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Book Value:
- The value of shareholders’ equity derived by subtracting total liabilities from total assets.
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Liquidation Value:
- Represents the net cash a business would receive if its assets were liquidated and liabilities paid off today.
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Note: Other methods include replacement value, breakup value, asset-based valuation, and more.
4. Accreditation in Business Valuation:
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In the U.S., the Accredited in Business Valuation (ABV) designation is awarded to accountants, particularly CPAs, specializing in business valuation.
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Administered by the American Institute of Certified Public Accountants (AICPA), the ABV certification involves an application process, an exam, and ongoing requirements.
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In Canada, the Chartered Business Valuator (CBV) is a professional designation offered by the Canadian Institute of Chartered Business Valuators (CICBV).
In conclusion, my expertise in business valuation encompasses a thorough understanding of valuation methods, their practical applications, and the professional certifications essential in this specialized field.
