Business valuation has always been a point of convergence in the world of corporate finance. There are various critical questions that corporate finance always tries to figure out like, how & where should a business invest its resources? What would be the best figure a business may return to its owners? How to raise funds to finance the investments? Questions like these can only be answered correctly by doing a business valuation.
Business valuation is the process of calculating the current worth of the company that allows companies to sell all or a portion of its operations. It is even required if acquisitions or merging business are already a significant part of your business growth strategy.
“All the business valuation methods include various facts and figures concerning the real worth of the company in terms of asset values, market competition, and income values”.
Business valuation is even essential for tax reporting as well. The IRS, or the Internal Revenue Service, necessitates that businesses should be valued on the basis of fair market value. Some tax-related events, such as gifting/buying, or sale of shares of a company are usually taxed depending on their business valuations.
Looking beyond the traditional numerical due diligence permits buyers to calculate the actual value of their company. And from the seller’s point of view, business valuation helps them to justify a higher asking price.
Here are the three most common and efficient business valuation methods that may help you to figure out your business’s value.
1. Asset-Based Business Valuation Method
2. Market Value Business Valuation Method
3. ROI-Based Business Valuation Method
Let us have some brief insight over the business valuation methods listed above, so that you can calculate the real worth of your business.
1) What Is the Asset-Based Approach?
Firstly, we will try to understand the concept of asset-based business valuation methods, which are also referred to as cost-based methods. As its name suggests, it includes the net asset value of your business minus the value of its liabilities often concerning mutual or open-end funds, or according to your balance sheet.
Here we can make some interpretation concerning which of the company’s liabilities & assets may be included in the valuation of the business and measure the worth of each.
Understanding an Asset-Based Approach
Every financial executive has a responsibility to identify the value of a company. To keep up-to-minute updates of the changing value of the company is also very critical. Investors & stakeholders returns grow with the increase in the value of the company and similarly decreases with a falling value.
To identify the value of a company, we have many different ways available. However, the two most common are enterprise value & equity value. The asset-based approach is one of those business valuation methods that can be used in combination with these two ways or even as an independent valuation.
Both enterprise & equity value requires equity for calculation purposes. If the company does not have a large amount of equity, then the asset-based approach is the best alternative for business valuation. Stakeholders and investors use asset-based value for comprehensive valuation comparisons.
Calculating Asset-Based Value
For calculating a business entity valuation, the asset-based approach utilizes the value of the assets. This value is equivalent to the shareholders’ equity or company’s book value, in its most basic form. By subtracting the liabilities from the total number of assets, the final calculation is generated.
Mostly the results (value of assets minus liabilities) can be different from that of the balance sheet because of some timing & other critical factors. It includes those intangible assets that are usually not mentioned in the balance sheet.
Adjusting Net Assets
If we talk about the challenges that occur in such business valuation methods, adjusting of net assets would be ranked on the top-of-list. An adjusted asset-based valuation attempts to recognize the market value of assets in the market.
Over time, the balance sheet valuations utilize depreciation to reduce the value of assets. Therefore, we can say, the book value is not always considered as the fair market value.
Net asset adjustments also include intangible assets that cannot be valued fully on the balance sheet. An adjusted asset-based approach primary focuses on figuring out the fact stating, such as, what a company could potentially sell for? Although some companies do not find it necessary, these intangibles are vital to be considered in the current market.
In addition, adjusted net asset calculation is also done for adjusting liabilities, and market value adjustments have an excellent potential to increase or decrease the value of liabilities. Furthermore, it even affects the adjusted net assets calculation.
In short, these methods are promising for accurate business purchase price allocation, and are utilized as an essential element of a business acquisition deal.
2) What Is a Market Approach?
Market value approaches are one of the best ways for business valuation. It works to determine the real worth & value of your business by comparing it with other businesses in a similar niche that have been recently sold. It is a method of discovering the estimated value of an asset on the basis of the selling price of related items.
It is among those business valuation methods that can calculate the value of the property, securities, business ownership interests, or intangible assets. The market approach is also used to study up-to-date sales of similar assets and helps in making adjustments for deviations in quantity, size, or quality.
Understanding the Market Approach
To value publicly traded companies based on stock prices is relatively a simple task. However, in the US, less than 1% of all companies are publicly traded.
For those who are trying to achieve a reasonable price for an asset or privately held company, here are the two major types of market approaches to business valuation:
1) The Guideline Transaction Method: It uses values of similar companies that are sold in the recent past.
2) The Guideline Public Company Method: It utilizes the prices of similar companies that are traded publicly.
Examples of the Market Approach
If we consider an example of the real estate industry, you can determine the value of a property by observing comparables like recent property sales, which have similar features, size, or are located in proximity to the property that is being valued.
For example, while deriving the actual value of a growing cybersecurity company, an analyst might scan the companies (similar niche) that have recently gone public. The analyst would note whether or not newly IPO-ed and private firm target the same customer base, rely on similar processes for maintaining the security of their customers, or have related revenues.
Areas of Potential Concern
The analysts & investors must pay close attention to the figures for sales & revenues while utilizing the market approach to business valuation.
Let us say that there are two companies that are in the healthcare industry. One of the companies is a large pharma firm and the other is a small-cap biotechnology company. If an analyst compares the transactions of both of these firms, it would not be entirely relevant.
Therefore, it becomes more important to apply specific pricing multiples during the business valuation process. As an example, a trailing twelve months or TTM enterprise value multiple should not be applied while considering the next twelve months or NTM forecast of a company being valued.
3) What is the Return on Investment (ROI)?
Now, let us have a closer look at ROI-based business valuation methods. Before we dive in deep into the concept of ROI valuation method, sit back and think what would you consider as a primary concern for investing. Most people will think of return on their investment.
ROI is basically a performance measure that can evaluate the competence of return on investment. It can even give a comparison of the efficiency of different investments. Relative to the investment cost, ROI can measure the exact amount of return for a specific investment.
To calculate ROI, you have to divide the investment benefits (or return) by the total cost of investment, and the result will be expressed as a ratio or percentage.
ROI = (Current Value Investment – Total Cost of Investment) / Cost of Investment.
If any gains are obtained from the sale of the interest investments, this is referred to as “Current Value of Investment.” As the return on investment is measured as a percentage, a comparative analysis can be made on returns from other investments.
Breaking Down Return on Investment (ROI)
Because of the simplicity & versatility of ROI, it has become one of the more popular business valuation methods. It relies on the level of external & internal risks connected within a business. As a general rule of thumb for ROIs, the lower the risk, the lower the return on investment
Calculating Return On Investment
ROI-based business valuation methods are not only easy, but are one of the more feasible business valuation methods. You can assume the deal to be worthwhile if an investment’s return is positive. However, other opportunities with a tremendous return on investments are also available. Both of these signals can help a stake-holder or investors select or eliminate some of the options.
Since negative ROIs imply a net loss, investors should avoid it. As an example, let us assume Mr.X invested $2,000 in Pizza Corp. in 2018 and one year later, sold his stock shares for a total of $2,200. Now, to calculate the ROI, Mr. X would divide the net profits ($2,200 – $2,000 = $200). While the investment cost is $2,000, for an ROI of $200/$2,000, or 20%.
Using this ROI-based business valuation method, you can compare the investments made in the mentioned pizza company with the other projects or investments.
Developments in ROI
Nowadays, ROI-based business valuation methods are developing as Social Return on Investment,” or SROI-based business valuation methods. It has strengthened its roots since the early 2000s and has now become a much broader concept.
It is helping to learn the proposition of specific Environmental Social & Governance or ESG criteria. There are a few parameters that evolved from the emerging technologies that are putting a negative spin over traditional ROI. However, the net benefit may lead to a positive SROI.
How May Eqvista Help You?
As a business owner, you might have a basic idea about your company’s worth, but merely a guess-work is not enough. Therefore, if you want to figure out the fair market value of your company, you can follow a well-suited combination of the above-mentioned business valuation methods.
Above all, you need to manage your company shares & filings for your company properly. You can take the help of our Eqvista platform to track, manage, and make intelligent decisions about your ‘companies’ equity.
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