What Are The 5 Methods of A Business Valuation?

An understanding of the value of your business is significant for many reasons. For instance, if you intend to sell or buy another business, valuation lets you take part in the merger and acquisition process from an informed standpoint. Still, valuation is essential for tax reporting purposes as the sale of a business is taxable based on its valuation. 

A business valuation service in Sydney can facilitate and make light work of the process. Here’s an insider’s view of five standard methods a service provider can use to value your enterprise. Although this isn’t an exhaustive list or overview, it can point you in the right direction. 

1. Market Capitalization

Generally, market capitalization considers the aggregate value of a firm’s shares of stock. Computation of a business’ value using this approach involves multiplying the prevailing (current) share price by the enterprise’s total outstanding shares. Supposing your firm has 1 million shares whose current price is $20 a share. The market capitalization would be $20 million. 

Investors eyeing your company’s stock can also use such information to gauge the value of the shares they plan to acquire. Market cap is also an indication of a firm’s profitability and is a crucial metric in computing the price-to-earnings ratio. The P/E ratio makes it easier for investors to figure out if a business is undervalued or overvalued. 

2. Asset-Based Valuation

Asset-based approaches emphasize a firm’s fair market value (FMV). The idea behind such a valuation is to estimate the cost of creating a similar entity. To do this, value is determined by deducting the business’ total liabilities from its aggregate assets. 

As noted, the value of assets is usually estimated based on their current market prices. At the same time, the value of items such as inventory, cash, and other tangible assets is easy to determine. All the same, approximating the value of intangible items such as patents and trademarks can be demanding. 

Asset valuation may come in handy if you’re planning to wind up your business or even as a going concern. For instance, the net value is determined by settling all liabilities and selling a firm’s assets under a liquidation approach. 

3. Earnings Valuation

This valuation method hinges on the premise that a business can only generate value by creating future wealth. A common earnings valuation approach involves the capitalization of a firm’s earnings. Based on this method, a business valuation specialist works to determine how much an enterprise is likely to make in the future by taking past earnings into account.

Under a capitalization approach, a firm raises its value by creating sufficient income to foot its bills. An estimate of a business’s net present value, in this case, is realized by dividing future earnings by the capitalization rate. 

While the valuation of a partnership or a limited liability company using this approach can be straightforward, the same can’t be said of a sole proprietorship- finding an accurate measure of past earnings can be a tough ask. Case in point, how would you value customer loyalty as an intangible asset considering that it’s closely linked to the business owner?  

4. Market/Relative Valuation

To find the value of an enterprise using this approach, we consider the estimated value of similar companies. In short, we try to figure out how much we can expect from selling similar business assets. 

By also analyzing how much similar assets were sold by other entities and adjusting for issues such as size or quality, relative valuation can provide an accurate estimate of the assets’ value. Besides, this method can be applied alongside other approaches. 

It’s also ideal for estimating the fair value of the intangible business property such as security, goodwill, and intellectual property. The downside of this market valuation is that it’s only feasible to find similar comparable businesses. 

5. Discounted Cash Flow (DCF)

A DCF valuation attempts to project a company’s future cash flow and adjusts it to establish a fair market value. An analysis using this method also allows inflation to provide a realistic value assessment. If market instabilities are likely to affect your firm’s profitability, the DCF valuation can help paint a clear picture of where your business is headed. 

An analytical discounted approach requires the application of a financial model- implying data input and detail. It also makes various assumptions and necessitates multiple estimates to create a near-accurate valuation. Based on a DCF model, a business analyst can also assess how different scenarios impact forecasted values. 

In closing, each approach has its fair share of upsides and downsides. The method you choose won’t be a cure-all. But, adopting multiple approaches or a combination of methods can provide a better assessment or measure of your business’ value. Overall, consider working with a business valuation service to gain a solid understanding of what the process entails.