What Is a Business Valuation?
A business valuation is the process of determining the economic value of a business. It's also known as a company valuation. All areas of a business are analyzed during the valuation process to determine its worth and the value of its departments or units.
A business valuation is often used during the process of negotiating the merger or acquisition of one company by another but it might be used in other situations as well. 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.
- Business valuation methods include looking at market cap, earnings multipliers, or book value.
- The tools used for valuation can vary among evaluators, businesses, and industries.
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How Business Valuation Works
The valuation of a business is the process of determining the current worth of a business using objective measures. It evaluates all aspects of the business. Business valuation is typically conducted when a company is looking to sell all or a portion of its operations. It's also used during a merger or acquisition of one company by another as well as when establishing partner ownership, for taxation,and even as a part of divorce proceedings.
A business valuation might include an analysis of the company's:
- Management
- Capital structure
- Future earnings prospects
- Market value
The tools used for valuation can vary among evaluators, businesses, and industries. Common approaches to business valuation include a review of financial statements and discounted cash flow models.
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.
Methods of Valuation
A company can be valued in numerous ways. Each provides a different view of a company's value and no method is inherently more correct than another.
1. Market Capitalization
Market capitalization is the simplest method of business valuation. It's calculated by multiplying the company’s share price by its total number of shares outstanding.
Microsoft Inc. traded at $406.02 as of Aug. 9, 2024. The company could then be valued at $406.02 x 7.43 billion or about $3 trillion with a total number of shares outstanding of 7.43 billion,
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
A stream of revenues generated over a certain period of time is applied to a multiplier which depends on the industry and economic environment under the times revenue business valuation method. A tech company may be valued at 3x revenue while a service firm may be valued at 0.5x revenue.
3. Earnings Multiplier
The earnings multiplier may be used instead of the times revenue method to get a more accurate picture of the real value of a company because a company’s profits are a more reliable indicator of its financial success than sales revenue. The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period. 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 considers inflation in calculating the present value.
5. Book Value
This is the value of shareholders’ equity in 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 are liquidated and its liabilities are paid off today.
There are many ways to value a company and industries will have standards that they use. Other options include replacement value, breakup value, and asset-based valuation.
What Is Market Capitalization?
Market capitalization represents the total market value of all a company's shares. It's sometimes referred to as market cap. This value isn't fixed. It will fluctuate as the price of shares rises and falls and it depends on how many outstanding shares a company currently has. It can be found by multiplying the number of outstanding shares by the price per share.
What Does Business Valuation Tell You?
Business valuation tells you the dollar value of a company, which is usually determined by a combination of its assets, liabilities, earnings, potential future earnings, and market capitalization. It often represents what a buyer would have to pay to purchase the company outright although it's not only used for mergers or acquisitions.
What Does Accredited in Business Valuation Mean?
Accredited in Business Valuation (ABV) is a professional designation awarded in the U.S. to accountants such asCPAs who specialize in calculating the value of businesses. The certification is overseen by theAmerican Institute of Certified Public Accountants(AICPA). Candidates must complete an application process, pass an exam, and meet minimum business experience and education requirements.
Annual membership dues depend on work status, role, and industry.
Chartered Business Valuator (CBV) is a professional designation for business valuation specialists in Canada. It's known as the Canadian Institute of Chartered Business Valuators, also known as the CBV Institute.
The Bottom Line
A company valuation or business valuation is the practice of calculating an objective dollar value for a business or concern. Experts will examine its assets and liabilities, cash flows, earnings, or other metrics to determine the company's market value.
Business valuation is often determined as part of a merger or acquisition but it can also be used by investors or for tax purposes. A company can be valued in several ways so there's no single number that accurately represents a company's exact value.
