What Is a Business Valuation?
A business valuation is a general process of determining the economic value of a whole business or company 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. Owners will often go to professional business evaluators for an objective estimate of the value of the business.
The Basics of Business Valuation
The topic of business valuation is frequently discussed in corporate finance. Business valuation is typically conducted when a company is hoping to sell all or a portion of its operations or hoping to merge with or acquire another company. The valuation of a business is the process of determining the current worth of a business, utilizing objective measures, and evaluating all aspects of the business.
A business valuation could include an analysis of the company's management, its capital structure, its future earnings prospects or the market value of its assets. The apparatuses used for valuation can fluctuate among evaluators, businesses, and industries. Common approaches to business valuation include a review of financial statements, discounting cash flow models and comparative company comparisons.
Valuation is additionally important for tax reporting. The Internal Revenue Service (IRS) requires that a business is valued based on its fair market value. Some tax-related events like sale, purchase or giving of shares of a company will be taxed depending on valuation.
Estimating the fair value of a business is an art and a science; there are several conventional models that can be used, yet picking the right one and afterward the appropriate inputs can be somewhat subjective.
Special Considerations: Methods of Valuation
There are numerous ways a company can be valued. You'll learn about several of these methods below.
1. Market Capitalization
Market capitalization is the simplest method of business valuation. It is calculated by multiplying the company's share price by its total number of shares outstanding. For example, as of January 3, 2018, Microsoft Inc. traded at $86.35. With a total number of shares outstanding of 7.715 billion, the company could then be valued at $86.35 x 7.715 billion = $666.19 billion.
2. Times Revenue Method
Under the times revenue business valuation 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. For example, a tech company might be valued at 3x revenue, while a service firm might be valued at 0.5x revenue.
3. Earnings Multiplier
Instead of the times revenue method, the earnings multiplier might be used to get a more accurate picture of the real value of a company, since a company's profits are a more reliable indicator of its financial success than sales revenue is. The earnings multiplier changes future profits against cash flow that could be invested at the current interest rate over the same period of time. In other words, it changes the current P/E ratio to account for current interest rates.
4. Discounted Cash Flow (DCF) Method
The DCF method of business valuation is like 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 principal difference between the discounted cash flow method and the profit multiplier method is that it takes inflation into consideration to calculate the present value.
5. Book Value
This is the value of shareholders' equity of a business as displayed on the balance sheet statement. The book value is derived by deducting the total liabilities of a company from its total assets.
6. Liquidation Value
Liquidation value is the net cash that a business will receive assuming that its assets were liquidated and liabilities were paid off today.
This is in no way, shape or form an exhaustive rundown of the business valuation methods being used today. Other methods include replacement value, breakup value, asset-based valuation regardless some more.
Accreditation in Business Valuation
In the U.S., Accredited in Business Valuation (ABV) is a professional designation awarded to accountants, for example, CPAs who specialize in working out the value of businesses. The ABV certification is overseen by the American Institute of Certified Public Accountants (AICPA) and requires candidates to complete an application process, pass an exam, meet least Business Experience and Education requirements, and pay a credential fee (as of Mar. 11, 2022, the annual fee for the ABV Credential was $380).
Keeping up with the ABV credential likewise requires those who hold the certification to meet least standards for work experience and lifelong learning. Successful applicants earn the right to use the ABV designation with their names, which can improve job opportunities, professional reputation and pay. In Canada, Chartered Business Valuator (CBV) is a professional designation for business valuation specialists. It is offered by the Canadian Institute of Chartered Business Valuators (CICBV).
- Several methods of esteeming a business exist, for example, taking a gander at its market cap, earnings multipliers, or book value, among others.
- 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.