Business valuation is the process of determining the economic value of a business or company. Financial market participants including business buyers and sellers, corporations, banks, portfolio managers, and venture capitalists use valuation to determine the price they or their client is willing to pay or receive during the sale of a business.

Knowing the most basic concepts of business valuation goes a long way in determining the approximate worth of your interest in a business or if you are selling your business, it gives you an idea of a realistic selling price.

Watch this video to learn how to determine a company’s worth using iCFO’s Business Valuation Calculator Module:

Our Business Valuation Calculator Features:

• Analyze existing or past performance to obtain an estimated company value.

• Quick benchmarking against industry peers.

Benefits

• Quick assessment of a company’s worth based on a variety of effective business valuation methodologies.

• Provides a good initial estimate of a company’s worth.

Why Should You Learn about Valuations?

“Valuation is an important skill set to have, largely for portfolio managers,” said Mark Staniszewski, iCFO account manager. “The majority of business owners don’t have valuation skills and thus, end up paying a premium for formal valuations.”

Learning how to calculate business valuation eliminates the need to pay these prices for a business appraiser – if all you need is a ball-park perspective of a company’s worth.

Learning business valuation also allows the decision-makers to make better decisions. The financial and operational decisions that have been made, currently applied, and prospectively planned within a company all impact its current and future value.

Moreover, a deeper understanding of business valuation allows decision-makers to maximize value-enhancing strategies and minimize value-reducing mishaps.

What is Value?

Value is usually defined as the power of a good to command other goods or services when exchanged.

People perceive value differently than other people. The meaning of value changes when we buy an asset vs. when we sell it. The asset you’re selling typically no longer has value to you if you’re selling it.

In business valuation, you’ll most likely hear these two terms:

Fair Market Value – according to the Internal Revenue Service, this is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.

Investment Value  – The value of a property to a particular investor, based on an investor’s requirements, financing and tax rate.

Now that some terms are defined, you will need to research your environment before diving into the process of business valuation:

Research

1. Analyze Surrounding Economic Conditions
Research the current vitality of your industry as well as local and regional economic conditions. This will impact the value of the business you’re examining.

2. Analyze a Peer’s Similar Transaction
You should research a similar transaction to your proposed financing deal structure so you can project some things for yourself. Examine how the deals panned out for both parties and what percent ownership investors acquired.

Make sure the company you are analyzing is in a similar life stage, geographic proximity, and comparable in size of:

• Market
• Number of employees
• Product type
• Industry

Business Valuation Methods

There are many methods used to determine a company’s worth, but here are five commonly used business valuation methods:

1. Book Value

This is the most simple technique for determining what a company is worth. The book value is the value an asset carries on a balance sheet (the summary of the company’s financial balances).

So, what you get is value represented in numbers. To calculate book value, subtract intangible assets and liabilities from total assets.

Book value is a solid starting point for evaluation, giving you a foundation to base other analyses off of. It’s important to note that accounting practices have a significant effect on book value and should be taken into consideration.

2. Adjusted Book Value (ABV) or Modified Book Value

The adjusted book value is the book value of a company’s balance sheet after the value of assets and liabilities is increased or decreased to reflect their fair market value, which the book value does not accurately reflect.

The ABV excludes intangible assets and contingent liabilities, which is an often-criticized part of the method. This can be a good way to display the equity of a company, but critics don’t consider it to be a fair measure of a business’s value. This is, however, a better tool used for valuing distressed businesses.

3. Liquidation Value

This particular practice is not usually of any importance to a buyer or seller, but to investors who need to know everything about a company. This estimates the value that could be made from a quick sale but is merely an indication rather than a concrete estimate to base decisions off of. Basically, liquidation value refers to the worth of a company’s physical assets as it steps out of business.

4. Market Multiples Analysis 

A market multiples analysis, also referred to as a direct comparison or comparable companies analysis, uses comparable businesses in your industry to assess value.

The analysis can compare companies based on size, industry, technology, financial ratios, customers, growth, and leverage. Market multiples analysis uses averages to produce more broad-range, but accurate results.

This approach is easy to use. You won’t need to project cash flows and it’s easy to understand. This tool is widely used in the in the legal and investment banking fields. Components/ratios of this approach are:

• Price to Earnings Multiple
• Price to Sales Multiple
• Price to Invested Capital
• Price to Book Value

Note: Without a comparable company, results could be unreliable and could lead to a broad range of valuations.

This is also a good method to use when an alternative method is not appropriate due to rapid growth or short company tenure.

5. Net Present Value (NPV)

This value is the difference between the present value of cash inflows and cash outflows. The NPV is a cash flow summary designed to reflect the time value of money since a dollar earned in the future won’t be worth as much as it is earned today.

You need to use the Discounted Cash Flow Analysis to determine the Net Present Value. Using this method, a business’s cash flows are discounted back to the present value using a market-adjusted discount rate.

Applying the Basics

Business valuations are much more complex than these basic methods (which aren’t so basic!)

However, these methods do fall into one of the traditional categories of business valuation approaches: assessment of business assets and liabilities (Asset Approach), historical earnings, future earnings (Income Approach), and industry or market-specific trends and multiples (Market Approach).

We recommend you use a combination of these business valuation methods for a more comprehensive approach to determining business valuation. Realizing business valuations are complex, we recommend using a business appraiser to help you get results beyond an estimated business value.

When combined with iCFO’s other tools, business advisors (or even owners) can detect opportunities for performance improvement. Using our other tools, you can model ‘what-if’ scenarios, which are designed to improve factors like profitability and growth.

Business advisors will then be better poised to show the impacts of various decisions on a company’s value – ultimately helping the business owner plan more effectively for their planned exit or company sale.

Along with iCFO’s Business Valuation Calculator Module, here are a few helpful business valuation resources:

• Wikipedia 
• BizFilings