Introduction to Business Valuation
Valuation is more an art based on professional experience of the valuer rather than a science based on empirical studies and logics. Business Valuation is the process of determining the "Economic Worth" of a company based on its Business Model under certain assumptions and limiting condition and subject to data available on the valuation date.
It is an important concept in corporate finance and business management. Supposing a business is for sale, how does one know what is the real value that business is worth? More basically, how does a business owner know the net value of his business, or how is valuing a business for sale accomplished?
Areas where valuation is used
How much is my company worth?
What are the unique, tangible and intangible assets (value components) we have to offer?
How much should I pay for this investment opportunity?
Can I earn an appropriate return on investment (ROI) to justify the risk being taken?
The art of valuation lies in identifying the key value drivers and the key risk areas after
analyzing the following:
Generally acceptable methodologies of valuation
A number of business valuation models can be constructed that utilize various methods under the broad business valuation approaches. Most treatises and court decisions encourage the valuer to consider more than one method, which must be reconciled with each other to arrive at a value conclusion. Understanding of the internal resources and intellectual capital of the business being valued is as important as the economic, industrial and social environment.
The choice of the appropriate valuation approach (or approaches) to be used in a given valuation project is based on the judgment of the valuer. The valuer’s choice of methods is determined by the characteristics of the business to be valued, the purpose and use of the valuation and its report, the pattern of historical performance and earnings of the subject company, the company’s competitive market position, experience and quality of management, the availability of reliable information requisite to the various valuation methods, the marketability of equity ownership interest to be valued, and others. These factors are summarized below:
- History and nature of the business
- Industry and general economic outlook
- Book value and financial condition
- Earning capacity
- Dividend-paying capacity
- Prior sales and size of the block of stock; and
- Comparisons to similar publicly traded
There are broadly three approaches of valuation:
- Asset Approach
- Income Approach
- Market Approach
Methodologies of Valuation