Company Valuation Methods

Valuation Methods for Company

When taking part in any form of business, it is essential for one to be aware of the value or worth of that business. It is this process of finding out the cost of a company that is its valuation. It is necessary for several occasions such as in an instance where one intends to sell their business. The buyer has to be aware of the value of the company before they buy it. Also, the knowledge prevents undercharging or overcharging in the process of buying and selling. Consequently, several methods exist for finding the value of a business. The methods vary depending on the type of business or the kind of product or service that it involves in. This essay discusses and compares the main techniques of company valuation.

Market Capitalization Method

The first company valuation method is the market capitalization. It is one of the simplest ways of finding out the value or worth of a company. It does this with the aid of only the stock involved in the business. Furthermore, it gives an idea of the way a particular stock may sell. Computing of market valuation using the market capitalization procedure involves multiplying the number of shares available (outstanding shares) by the price of an average share. A significant advantage of this method is that it not only computes a company’s valuation but also gives the level of risk involved in dealing with a particular stock. It also enables one to know the worth of a business or company. A shortcoming of this method is that it omits several vital factors in the calculation as it solely involves the available stock (Laidre, 2017).

Book Value Method

The second company valuation method is the book value method. It involves tabulations on all of the business assets, done on a balance sheet. The calculations include taking into consideration the value of a specific asset and subtracting from it the depreciation that accumulates (subtracting the value of the total assets from the total liabilities). The net asset value is another term for this method. Book value method is only applicable when the assets involved are significant and when the business is not too small. A company may be gaining a low profit but has a high book value meaning that it runs on highly valuable assets. In such a situation, when selling the business, it is essential to consider the book value (Nicholas, 1990). An advantage of the book value method is that it narrows down into the minor details of the company, unlike the market capitalization method which only deals with one aspect which is the stock. A shortcoming of this method is that it is only applicable where a company sells with substantial and tangible assets as it is not easy to record an intangible asset (Beattie, 2018).

Expected Future Earnings Method

Expected future earnings method is the third method of company valuation. This method, just as its name suggests, outdoes most of the other ways in that it also calculates the value of the company in the near future. Most of the other methods mostly involve the present and the past. The expected future earnings method takes into consideration several factors to project the future value of the company. One of the ways is by accounting for the value of replacement of the company assets. It also looks at the ability of the company to maintain its consistency in getting earnings in the future as it does in the present (Boyd, Epstein, Holtzman, Kass-Shraibman, Loughran, Sampath, and Welytok, 2014). An advantage of this method over all the others is that it projects the future worth of the business whereas others deal with the present value. A significant shortcoming of this method is that in anticipating the future, there may be unforeseen circumstances for which will consequently be unaccounted. The estimates may also be wrong as it deals with predictions.

Profit Multiplier Method

The fourth method of company valuation is the profit multiplier. Here, the buyer attempts to find out how much he or she is likely to earn from a business before buying it. He or she calculates the worth of business by multiplying its profit by a preferred period within which he would like to know how much it would earn in return. The result gives a hint on the possible profit of the specific business. This method, similar to the expected future earnings method, works to calculate the future worth of a business, the only difference is that the profit multiplier majors on calculating the future profits while the expected future earnings majors on the general possible cash flow of the company. The primary distinction between this method and the others is that it only deals with the profits. Other than that, it is similar to the expected future earnings method (Laidre, 2017). This method is advantageous in that it not only enables one to purchase a good business but also one with the right amount of profits. Other company valuation methods major on the worth of the company assets and ignore the profits that it is likely to generate. A significant shortcoming of this method is that it ignores the concept of inflation in its calculations. It means that the chances are high that the calculated profit is not always the exact result after the specified period.

Conclusion

This essay comprehensively discusses the basic methods of company valuation and points out some of their significances. It is highly significant that one is aware of the worth of their business for several reasons. One may need to know the expectations they are to have from the business. It is also vital such that in the cases of the splitting of the business, each one gets an equal and deserved share. It only happens when the division process begins from the point where the worth of the entire company is known. Furthermore, the knowledge is essential in other circumstances such as selling the business. When a business owner is aware of the worth of their business, they sell it for the right value and not more or less. However, this is prone to change depending on the assets of the company that it uses and that it does not. As discussed above, a company may appear to have a low worth despite the presence of valuable assets that it does not use.

References

Beattie, A. (2018). Book Value: How Reliable Is It For Investors? Investopedia. Retrieved on

February 16, 2018, from https://www.investopedia.com/articles/fundamental-analysis/09/book-value-basics.asp

Boyd, K., Epstein, L., Holtzman, M. P., Kass-Shraibman, F., Loughran, M., Sampath, V. S., and

Welytok, J. G. (2014). Accounting All-in-one for Dummies. John Wiley & Sons.

Laidre, A. (2017). Business Valuation Methods. Retrieved on February 16, 2018, from

http://exitadviser.com/business-value.aspx?id=business-valuation-methods

Nicholas, D. W. (1990). Adjusted-Book-Value Approach to Valuation. ICFA Continuing

Education Series, (2), 31-37.