What is Company Valuation?

Company valuation or business valuation is the process of evaluating the economic worth of a business or a company unit. It helps stakeholders understand the market worth of a business. 

The value of a business is calculated before a merger, expansion or any major business event. There are many techniques to calculate the value of a company to ascertain the value of the business. This evaluation is used to analyze parameters like the business’s future earnings prospects, capital structure, company management, etc.

Basics of Company Valuation

Some common approaches that businesses consider when valuing the business are discounting cash flow models, scrutinising financial statements, comparing with other companies with similar working patterns etc. Business owners generally seek the help of a professional business evaluator to get an objective evaluation of the business’s worth. 

Company valuation plays a major role in tax reporting as well. As per the IRS (Internal Revenue Service), the business valuation must be on the basis of fair market value. Further, business operations like sales, purchasing shares of a company, etc., fall under taxation based on valuation. 

Read more: Corporate Tax 

Different Methods of Company Valuation

1. Times Revenue Method

The Times Revenue Method is a simplified approach used to estimate the value of a company based on its annual revenue. It is commonly used by small businesses, startups, or companies with limited historical data or earnings. The method involves multiplying the company’s revenue by a predetermined multiple to arrive at its estimated value.

This method is often used as a starting point or in conjunction with other valuation methods to arrive at a more accurate estimate since this is a highly simplified method of valuation.

Read more: Gross Profit

2. Earnings Multiplier

The earnings multiplier method is a more accurate way of calculating a company’s value. This is because considering a company’s profit is a more reliable indicator of a company’s success than revenue.  

This method compares the company’s earnings to the market value of its shares and calculates a multiple that is then applied to its earnings to estimate its value.

The multiple is typically derived from the valuation of similar companies in the market or industry. For example, if comparable companies are trading at an average P/E ratio of 15, you might choose to apply a similar multiple to the subject company.

The formula used in this method:

Business value = Earnings of a Business x Multiplier

3. DCF (Discounted Cash Flow) Method

Discounted cash flow method is the most detailed way to analyse the value of a business and demands the most assumptions and estimates. This kind of business valuation is almost the same as the earnings multiplier method and is based on future cash flows projection. These are balanced to obtain a company’s current market value. 

The main difference between the DCF Method and Earnings Multiplier method is that the DCF Method takes inflation into consideration for the calculations. 

4. Market Capitalisation

This is perhaps the simplest means of carrying out company valuation. In this method, the computation of business valuation takes place by multiplying the share price of a company by its total number of shares. This method is also used to compute a company’s size and industry shares. The formula of the market capitalization method is-

Valuation = Share Price x Total number of shares

Outstanding Shares = Total Issued Stock (–) Treasury Shares

A shortcoming of this market capitalisation method is that it only takes into consideration equity valuation, while most business bodies rely on a mix of equity and debt. 

5. Book Value

In this method, businesses calculate company valuation from the book value collected from the data available on a balance sheet. Book value is calculated by subtracting the company’s liabilities from the asset and evaluating the equity of the shareholder. For this process, deduct the value of intangibles in order to value the tangible assets. 

Importance of Conducting Business Valuation

  • Strategic Planning

One of the most important reasons why conducting business valuation is necessary is that it aids strategic planning. A business valuation helps recognise mispriced securities and understand which projects a business body must invest in. Business bodies must focus on investing in projects that will enhance the net present value. Any investment-related decision is based on mini-valuation and is dependent on value creation as well as future profitability. 

  • Purchasing or Selling Business

Even this business valuation proves beneficial during selling and buying a business.  It is to ensure that both sellers and buyers can take an informed decision while going ahead with buying and selling, thus making the move profitable. 

  • Capital Financing

A business valuation helps business owners when they have to negotiate with financial institutions for funding. The documents stating the business’s worth and its potential of generating cash flow help business owners establish credibility with equity investors and lenders. 

Read more: Business Plan

  • Investing in Securities 

Making an investment in any securities can prove counterproductive if a proper analysis of the market does not take place. A business valuation helps determine the intrinsic value of an investment. 

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What are the tips that will help in determining a business value?

Here are some of the basic tips that analysts follow while they conduct company valuation: Firstly, it is important to choose a particular valuation method depending on the business nature, company size, market condition, etc. Gauge out the business growth rate which is the change caused in the variable over a span. Business bodies can benefit from collecting data on other business entities (of the same structure and operation) and understanding their economic value. Business owners must analyse their profitability and work on enhancing it by studying revenue data and sales.

What is comparable company analysis?

Comparable Company Analysis (Comps) refers to the relative valuation method where one compares the business’s current value with other similar patterned business bodies on the basis of trading multiples like EBITDA/ EV, P/E, etc.

Is the valuation charge tax deductible?

No, the business valuation fees are tax deductible

Can one use the enterprise value method to determine the company value?

Yes, the enterprise value method is another effective method that one can use to evaluate the company valuation. It is, in fact, an alternative method that is used to cover the limitation of the market capitalisation method. In this process, different capital structures like equity, cash, debt, etc., are used to determine company valuation.


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