Business valuation is the process of determining the market value of a business. A lot of stakeholders like investors, creditors, and others are interested in the valuation of a business. However, the market value of a business is the price that shareholders will pay for the stock of the company on the capital market. If you are trying to determine the worth of a business, there are many methods to use. So, the article explains different methods of valuing a business.
Business valuation Methods
- Market Capitalization
- Comparable method
- Asset-based valuation method
- Earnings multiplier method
- Discounted cash flow method
Market capitalization is the straightforward method of valuing a business. Market capitalization is the market value of all outstanding shares of a company. It is calculated by multiplying the total number of shares outstanding in an organization by its share price. The share price of a company can be publicly accessed by searching for the name or a symbol of the company on different finance websites such Bloomberg, Yahoo Finance, or Google Finance.
However, the total number of shares outstanding of the company can be extracted from its balance sheet on the same website as the share price. Therefore, by multiplying the current share price by the stock outstanding of the company, you have market capitalization. For example, consider company A with 500,000 shares outstanding and the current share price of $10. Therefore, the company’s market value will be $5,000,000 (500,000 * $10)
You can use this method when the company is a private company or the market capitalization of the company seems unrealistic due to some reasons. The comparable method is a method of determining the market value of a business by comparing the current value of a business with other similar businesses using P/E, EBITDA, or other ratios. While choosing the company to compare, the company must be relatively the same size, the same sales, the same profits, and in the same industry with the business, you are valuing.
However, if you are valuing a private company, you can use publicly traded companies of the same size and in the same industry for comparison. More so, this method helps to determine the observable value for a business based on what other businesses are worth currently. For example, considering that you want to calculate the market value of company A that has earnings of $3 per share and a share outstanding of 200,000 shares. If the selected company for comparison, company B has a P/E ratio of 15 times. However, the market value of company A will be $45 per share ($3*15). The total value will be $9,000,000 ($45 * 200,000).
Asset-based valuation method
This method of business valuation involves subtracting the total liabilities of a company from its total assets to determine market value. This method is regarded as shareholder’s equity as it is in the balance sheet of the company. The method can be used in two ways; going concerned and liquidation.
This is used when the business plans to continue operation. Therefore, you will make use of total assets in the balance sheet minus total liabilities. I.e. assets minus liabilities. It is known as the book value method.
This one is used when the business plans to cease the operation. Therefore, the liquidation value will be net cash that would be received to sell all assets and the amount that would be paid to transfer all liabilities.
Earnings multiplier method
The multiplier method is used to determine the market value of a business by multiplying income figures such as gross profit, net profit, or gross sales by an appropriate coefficient. This method adjusts the future profits of a company against its cash flow to be invested based on the current interest rate over a particular period. The method is used as a preliminary method of valuing a business and it is just a rough estimation of the market value.
Discounted cash flow method
DCF method involves the projection of the future cash flows of a business that are adjusted using the firm’s weighted average cost of capital (WACC) to determine the current market value of the company. This method is similar to the earnings multiplier method except that it considers inflation in the determination of present value. It is considered the most detailed method of business valuation that require a lot of estimates and assumptions
It is important to understand different business valuation methods to evaluate the worth of a business. However, most companies use a combination of these methods to have the real value of their business. More so, in determining the value of your business, you may need the advice of a professional to calculate the accurate market value.
Afeez is one of the founding partners of Marasas Consulting limited. He consults for both individuals and entities in the area of accounting, management, audit, tax, and investment. He has a wide range of experience both online and offline which allows him to provide relevant and timely professional advice and assistance to business owners with their accounting, tax, management, audit, and investment plans.
Afeez is a member of the Institute of Chartered Accountants of Nigeria (ICAN) and a member of the Nigerian Institute of Management (Chartered). He is a certified Google analyst and strategist. He earned his Bachelor degree in Management and Accounting from Obafemi Awolowo University, Ile-Ife, Nigeria, and earned an ordinary national diploma in Accountancy from The Polytechnic of Ibadan, Oyo State, Nigeria. He earned certification in “Excel Crash Course” and “Reading of Financial Statement” from Corporate Finance Institute, Canada.
Afeez is dedicated to helping clients achieve business success by helping them to establish solid and sound accounting, tax, and financial processes.