Six Business Valuation Methods You Should Know

The process of determining the economic value of your company is known as business valuation. There are several circumstances where a business valuation may be necessary. For example, you may need to value your business in relation to a corporate exercise/transaction or for compliance purposes such as audit or taxation.

Having a clear understanding of your company’s value is important when making business and financial decisions. Business owners and managers commonly work with professional business valuers who apply different valuation approaches to arrive at an independent estimation of the subject company’s worth. This valuation is also useful when dealing with shareholders and potential investors.

There are various methods for determining a company’s worth. An appropriate combination, i.e., a primary method and a secondary method/appropriate crosschecks, can help produce a more robust and comprehensive independent valuation of the company. The six key business valuation methods are as follows:

Market Benchmark Valuation

The market benchmark value of a business is a common way of determining a startup or early-stage company’s worth in Singapore, Malaysia and elsewhere in Asia. This involves comparing your company’s potential value to the value of businesses at a similar stage operating in a comparable industry or market, i.e., comparable companies, that have been bought or sold.

This technique of estimating company value is only effective for companies with access to relevant market benchmarks such as fundraising information or transaction data relating to comparable companies. It is not ideal where the companies used as benchmarks are not sufficiently comparable or where obtaining relevant market benchmark data is not available or is quite tricky to get.

In addition, employing the market benchmark technique requires appropriate adjustments to the available market data and professional judgment. As such, there is a risk that the resulting estimate may be imprecise, particularly if you are not experienced in such matters.

ROI Based Valuation

An ROI-based valuation technique assesses the worth of a business based on earnings and the potential return on investment that an investor could obtain from acquiring or investing in the company. It is commonly used by venture capitalists, private equity funds and other similar investors.

It is a useful business valuation approach, particularly when assessing value from an investor’s perspective. Before investing in a company, a prudent investor will gather all of the necessary information regarding the potential return that may be generated from the investment.

However, due to changing market conditions, ROI tends to change significantly, making the ROI-based valuation technique volatile and highly dependent on assumptions and judgment.

Discounted Cash Flow Valuation

The discounted cash flow (DCF) valuation method is commonly employed in Singapore, Malaysia and elsewhere in Asia and is useful for early-stage companies with strong growth, uneven or fluctuating cash flows, or a fixed life of the underlying business such as a concession-based business (toll road or other infrastructure assets), mining, etc.

It requires a larger number of inputs and assumptions and as such can be more challenging than other methods to perform in practice.

As it involves estimating a company’s worth based on its expected future cash flows, it falls under the income approach of valuation. It is a useful way to value your company, especially if you don’t expect your revenue and earnings to increase substantially in the immediate future.

Capitalization of Earnings Valuation

The capitalization of earnings valuation method is similar to the DCF valuation method in that it is essentially a shorter approach to the same income-based concept. It entails determining the worth of a company or equity in it based on near-term cash flow or anticipated earnings and benchmarking against the relevant market multiples or transaction multiples of comparable companies.

This is done after making other adjustments for size, profitability, business model, diversification and other risk and reward differences between the relevant company and the comparable companies as well as for marketability discount, control premium, minority discount, etc., as relevant. It’s useful if your company operates with relatively stable operations and a consistent earnings base and you don’t expect a lot of fluctuations.

Asset-Based Valuation

Asset-based valuation is a popular way of valuing businesses, which are capital-intensive or rely significantly on their asset base to generate revenue and profits. It entails calculating the company’s net asset worth after deducting the value of its liabilities from the value of its assets.

The going-concern technique should be used to assess the more realistic value of a company that intends to continue functioning, i.e., making adjustments to arrive at appropriate market values for the assets and liabilities without incorporating closure costs.

For companies that are planning to close down or operating with the expectation of closing down in the near term, one should use the liquidation value asset-based valuation method. The value is established in this scenario based on the net cash expected to be received by the owners when the company is shut down.

Book Value Valuation

Some businesses utilize book value as a technique of valuing their company. It entails reviewing the company’s balance sheet and using the recorded values of its assets and liabilities to estimate its worth. A balance sheet provides all of the necessary information regarding the value of the inventory, receivables, payables, fixed and other assets, and liabilities for determining the value.

However, it is only suited for businesses that are loss-making or have low profitability, and the book values may not reflect the intrinsic value based on the earnings potential or even the current market value of the assets recorded on the balance sheet.

Conclusion

These are the six business valuation methods that can be very useful to consider if you’re looking at options to expand or develop your business, including fundraising, bringing in new shareholders or pursuing M&A opportunities, etc., or require a valuation for compliance purposes.