Business valuations involve a formal analysis“>analysis of the key operational aspects of a business. A business valuation is an analysis“>analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
Understanding a business valuation
These considerations ultimately result in an estimation of the value of the business concerned. While valuations are commonly associated with mergers and acquisitions, they are also useful for:
- Changes in business ownership or the bequeathing of shares to children as part of succession planning.
- The raising of investment capital.
- Divorce proceedings.
- Establishing the degree of joint-venture partner ownership.
- Taxation purposes.
Various business valuation approaches
Not all businesses are created equal, so there are several approaches that analysts can use to value a business.
1 – The cost approach.
This approach considers the cost involved in replacing or rebuilding an asset and is commonly used to value real estate or investment securities. It is not typically used to value a business that is a going concern.
2 – The market approach
Here, the analyst will assess the recent sales of comparable public businesses. Valuation adjustments may need to be made if there are major discrepancies between the business being valued and one already sold.
The market approach incorporates the comparable company analysis, or “comps” for short. This involves a comparison of trading multiples such as P/E and EBITDA – with the latter being one of the most common methods of valuation. Market capitalization, net debt, revenue, size (revenue, assets, employees), and even geographical context are also considered in other methods.
This approach obviously requires that similar businesses exist. Thus, it may be unsuitable for unusual, niche, or highly innovative companies.
3 – The discounted cash flow (DCF) approach
The DCF approach is the most comprehensive of the three because it assesses companies according to their intrinsic worth. The analysis requires that a financial model be created in Excel based on extensive data estimates and assumptions.
Data is used by the analyst to forecast free cash flow over a projected, future period. This is done by calculating the company’s Weighted Average Cost of Capital (WACC), or the expected returns required by debt and equity providers.
For larger organizations with multiple business units, the DCF approach models and values each unit separately. Then, unit valuations are combined to give a final valuation.
Although requiring significant upfront effort, the results of a DCF valuation are the most accurate.
- A business evaluation is a process whereby an experienced analyst values a business or company unit.
- Business evaluations are commonly seen in mergers and acquisitions. But they are also important in succession planning, capital raising, divorce proceedings, and the establishment of a joint-venture partnership.
- A business evaluation can be approached in three different ways. Although resource-intensive, the DCF approach is the most accurate because it considers the intrinsic value of a business.
Finanial Structure Modeling
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