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Six Business Valuation Methods You Should Know
The process of determining the economic value of your company is known as business valuation. There are a variety of situations in which a business valuation is required. 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. It is critical to understand the worth of your company to make informed decisions relating to it. Business owners and managers commonly use professional business valuers to undertake business valuation who use multiple methods 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, of these approaches result in a robust, comprehensive and independent valuation of your 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 similar stage businesses in similar industry/ market space, i.e., comparable companies, that have been bought or sold. This technique of estimation of a company value is only effective for companies with access to relevant market benchmarks such as fund raisings or transaction data of the comparable companies. It is not ideal where companies used as benchmarks are not really comparable or obtaining relevant market benchmark data is not available or is quite tricky to get. In addition, employing the market benchmark technique requires adjustments to the relevant market data and requires judgment, and as such there is high risk of imprecise estimations 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 sort of return on investment an investor would obtain by acquiring or investing in your company. It commonly used by venture capitalists, private equity funds and other similar investors.
It is a useful business valuation approach, particularly from an investor point of view. Before investing in a company, a prudent investor will gather all of the necessary information regarding the possible return on investment. However, due to changing market conditions, ROI tends to change significantly, making the ROI-based valuation technique volatile and highly subjective.
Discounted Cash Flow Valuation:
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, lumpy or uneven cash flows, fixed life of the underlying business such as a concession-based (toll road or other infrastructure assets), mining, etc. It requires more inputs and as such can be more challenging than other methods to perform in practice. As it includes 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 ramp up very soon.
Capitalization of Earnings Valuation:
The capitalization of earnings valuation method is similar to the DCF valuation method in that it is short cut to it. It entails determining the worth of a company or equity in it based on near term cash flow or expected earnings and benchmarking against the relevant market multiples or transaction multiples of the comparable companies after making other adjustments for size, profitability, business model, diversification and other risks and reward differentiation factors 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 a steady business with stable earnings base and you don’t expect a lot of fluctuations.
Asset-based valuation is a popular way of valuing businesses, which are capital intensive in nature or use their asset base to generate revenue and profits. It entails calculating the company’s net asset worth after deducting the liabilities’ value from the assets’ value. 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 equivalent market values of assets and liabilities and no 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 that the owners will receive if the company is shut down.
Book Value Valuation:
Some businesses utilize book value as a technique of valuing their company. It entails examining a company’s balance sheet and estimating the worth of the company. 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 loss making or low profitability businesses and the book values may not reflect the intrinsic value based on the earnings potential or even the market value of the assets on the balance sheet.
These are the six business valuation methods that can be very useful to consider if you’re looking at options to grow your business including, fund raising, getting new shareholders, M&A, etc., or require a valuation for compliance purposes.