What is a business valuation method?

 

A business valuation method is used in practice to determine the value of a company or project. Business valuations are therefore applied in situations where companies or shares are sold, merged or acquired.

Next to performing a business valuation in relation to transactions, it is also important for business owners to know the value of the company. By knowing the value, the value drivers and the impact on the value when altering the value drivers, business decisions can be made and a strategy can be drawn up for the longer term.

As such, a business valuation provides insight into where improvements can be made and how these improvements can lead to a higher value, e.g. at the time of a envisaged future sale. Business valuations are therefore an important element as part of making the company 'ready for sale',

To determine the business valuation, there are various methods available that can be used to determine the value of a company.

Different business valuation methods

There are many different methods that can be used to determine the value of a specific company. We have listed the most common methods.

Discounted Cash Flow (DCF) method

The DCF method is widely used and theoretically the most sound method to determine the value of a company. The DCF method is based on a company's expected future cash flows. The value of the company (or enterprise) is determined by calculating the present value of these cash flows. The value of the shares (or the equity value) is determined by subtracting the net-debt from the enterprise value.

This method takes into account a number of different factors. Next to the (expected) cash flows of the company, the risk factor and the time value of money are included. The DCF method is one of the most commonly used methods for business valuation.

Multiple method

The multiple method assumes that comparable companies, within the same industry and region, have comparable 'multiples'. The multiple is the factor by which the realized (or to be realized) result (e.g. turnover or operating profit) is multiplied to determine the enterprise value. This multiple can be found by looking at (comparable) listed companies or by looking at recent transactions in the market.

This method is relatively easy to perform. Yet this method is very limited in practice, especially when there are few companies that are truely comparable in size, earning potential, growth expectations, life stage and asset intensity. This makes the results of this method sometimes unreliable. This method is often used as a 'sanity check' on the DCF method.

Asset method

This business valuation method is sometimes used to determine the value of a company based on a company's assets. The liabilities are then subtracted from the value of the assets to determine the value of the shares.

In this method, the company's assets are valued at current market value. It is of course important to take any depreciation into account. In practice, this method is often applied to companies whose assets are the most important value of the company (e.g. real estate companies) or companies who have little operating activities (e.g. holding companies).

Unlike the DCF method, for example, this method does not use future cash flows. Therefore, this method is less suitable for companies for which the value depends on their growth potential.

Use the appropriate business valuation method

Using the right business valuation method to estimate the value of a company can be quite difficult. The choice of method is highly dependent on various factors. Consider the nature of the company and the available information.

If you would like to buy or sell a company, it is wise to apply the DCF method. This gives you a realistic picture of the value of the company. However, if you want to value a company that consists mainly of assets, the asset method can be an applicable method to determine the value.

Is there little data available for a particular company? In that case, it may be wise to use the multiple method to estimate the value of a company.

As you can see, it is sometimes very difficult to find and use a suitable method, because the method to be used depends greatly on the situation. Therefore, it may be important to consult a valuation expert to determine which method is most suitable for your situation. This way you can be sure that you use a method that best suits your situation, so that a good business valuation is carried out.