Business valuation is determining the fair value of an entity or organization that denotes its economic worth. Business valuation can be done for a number of reasons and purposes that include divorce proceedings, sale and purchase of the business, partner ownership process, and much more.
If we talk about the business valuation formula, then it can be defined as business assets minus liabilities. However, it is just the formula and not the method and process. There are different ways of calculating business valuation as detailed below:
1. Cost Approach
This is the most common, also known as the asset-based method. It is done by estimating the present value of the net tangible assets of the company. Then, from these assets liabilities are subtracted to find or calculate the fair value of the business. This method is most primarily used by manufacturing industries, owing to the number of tangible assets they own.
2. Income Approach
This is the second most method to calculate a business value. The future economic value is estimated which is converted to the present-day value. The most defining feature or aspect of this approach is the cash flow of the company. Companies that have a strong revenue-generating stream find their business valuation positive through this method.
3. Market Approach
The third method, the market approach takes competitors into consideration. The value estimators analyse the historical sales data of the competitors to determine the particular business’s valuation. Market multiples including earnings before taxes, tax depreciation, and amortization are the key factors of this valuation.
4. Market Capitalization Approach
It can be termed as the most common approach of all. It is a straightforward approach that calculates the fair value of a business by multiplying the outstanding shares’ total amount with the share price. The resulting answer is the valuation as per this approach.
5. Book Value Approach
This is a data-driven approach where the shareholder equity value and the balance sheet numbers are utilized to get the final amount. This is what we talked about as a formula earlier, i.e. total assets minus total liabilities amount.
Why Business Valuation?
A fair estimate of the economic worth of a business is highly critical for almost all functions and aspects related to that company. Thereby business valuation becomes a significant approach for them. This is applied for a number of reasons that include:
- Acquisition and Merger – Fair market value of the company helps to determine the return on investment potential.
- Financing – When a company seeks funding from investors then it becomes important to give a fair value of the company at present that determines the hold and the future profit return potential.
- Disputes – Whether it is a divorce process between partners or a case of conflicting interests of shareholders, the settlement has to be done after an accurate business valuation.
Conclusion:
Apart from these, there are many more scenarios where business valuation becomes important like creating marketing strategy in business plan, for taxes, for estate and gifting and many more. Whatever the purpose or the need, it should be done with an apt approach and by experienced professionals.
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