Business valuation is a critical process that is usually undertaken when a company is either being sold, merged with another company or plans to acquire a new business. It is also undertaken for tax reporting purposes. A business valuation helps in determining the value of a business as it entails the evaluation of all factors influencing the business through objective measures.
The business valuation includes analysis of aspects such as the company's management, capital structure, prospective earnings and the market value of its assets. The methods used vary depending on the business or the industry it is in.
Some of the well-known methods of business valuation are:
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Book Value – This is a fairly simple method of business valuation where the total liabilities are deducted from the total assets of the business to derive the book value.
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Discounted Cash Flow (DCF) Method – Projections of future cash flows are considered while calculating the current market value of the company. This method is similar to the profit multiplier model but the inflation rate is considered in calculating the present value.
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Relative Valuation: There are three different types of relative valuation:
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Revenue Multiple – As per this method of calculating business valuation, business revenues are applied a multiple, which is dependent upon the company performance, current industry and economic environment. This approach primarily looks at the growth potential with an ancillary view of the profitability
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Earnings before interest, taxes, depreciation, and amortization (EBITDA) Multiple – This valuation method is more complex than the others. It entails a comparable analysis that provides a normalized ratio for measuring the operations of different companies. The level of EBITDA plays a role in assigning multiples. Due to this variance, the potential risk versus return is taken into consideration and reflected in the EBITDA multiple used to calculate the value.
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Earnings Multiple – A lot of evaluators prefer the earning multiplier model to get a more accurate picture. This method is based on a company’s profits, a more reliable indicator of financial success compared to sales revenue. To calculate the business value, the projected profits are adjusted against the estimated cash flow reserved for future investment at the current interest rate over the same period.