Business valuation is a method by which worth of a business is estimated, and affected by the level of competition, earning potential, the level of industry, the range of products and breadth of customer base etc. It is not like the scientific process and provides estimated value which then used as starting point to negotiate a deal between counterparties. The reasons for valuation may be that you want to sell your business, you need a loan to run your business and you are adding a new partner in your business, everyone provides money before taking measures like valuation to secure their investments.
Business Valuation Methods
There are three ways of valuing a business:
Asset-based valuation method
In this approach, worth of company’s assets is calculated and taken as the worth of the whole company. This method can be used whether on going concern or on a liquidation basis. In going concern asset-based approach, a net worth of assets is calculated by excluding company liabilities whereas, in liquidation asset-based approach, net cash is determined that would be received if all asset are sold and liabilities paid off.
Earning-based valuation method
By using this approach, the earnings of the business are taken to estimate its value. For this, following formula will be used:
Value of company = Total earning / Earnings Yield
Value of company = Earning per share / Earnings Yield
Cash flow based valuation method
Under this approach, a value of the business is estimated by discounting future estimated cash flows with appropriate cost of capital. The cost of capital being used as discounting factor should reflect the systematic risk of the cash flows.