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Value of a company Evaluation & Equation | How to Value a Company

Value of a company Evaluation & Equation | How to Value a Company

In this article we will be discussing company evaluation and how you can get started with valuing your company. We will simplify business valuation so you can understand what it all means.

What is a company valuation? A company valuation is the process of determining the economic value of a company. This value can be used to help make investment decisions, set price targets, and negotiate acquisitions.

Value of a Company - How to value a company

 

In this article we will cover the following topics:

  • What is company valuation
  • What are the different valuation methods
  • Estimating discounted cash flows
  • How do investors evaluate my business
  • Private equity valuation metrics

 

What is company valuation?

As already mentioned Company valuation is the process of determining the economic value of a company. This can be done for a variety of reasons, such as for sale, investment, or tax purposes.

The value of a company is typically based on a number of factors, including its financial statements, assets, and liabilities.

 

Why do you need to know the value of your business?

People need to know the value of their companies for a variety of reasons. For example, if a company is being sold, the owners will need to know the value of the business in order to set a price.

 

Who you need to know the value of your business

 

Investors will also need to know the value of a company in order to make informed decisions about whether or not to invest. And, finally, tax authorities use company valuations to determine the amount of taxes that businesses owe.

 

History of Business Valuation

The science of valuation has evolved over the years, and today it is a well-established field of study. Company valuation belongs to the larger field of financial valuation, which is itself a subfield of economics.

The first company valuation methodology was developed in the early 1900s by two American economists, Irving Fisher and John Bates Clark. Since then, valuation methods have been refined and improved, and today there are a variety of different approaches that can be used to value a company.

 

History of business valuation

 

Over the years, the practice of company valuation has evolved as well. In the past, valuations were often performed by accountants or other financial professionals.

Today, there is a growing industry of professional valuation firms that specialize in valuation services. And, as the field of valuation has become more sophisticated, so too has the training and education of those who perform valuations.

There are now a number of colleges and universities that offer courses and programs in financial valuation.

 

Methods to Evaluate a Business's Worth

There are a number of different methods that can be used to value a company. Each method has its own advantages and disadvantages, and it is important to choose the right method for your particular situation.

The most common methods of company valuation are:

 

1. Discounted Cash Flow (DCF)

The discounted cash flow (DCF) method is a financial valuation technique that discounts future cash flows back to their present value. The DCF method is based on the premise that the value of a company is the sum of all its future cash flows.

 

Discounted cash flow method

 

The main advantages of the DCF method are that it is relatively simple to understand and it can be used to value companies of all sizes. The main disadvantage of the DCF method is that it is based on a number of assumptions, which may not always be accurate.

 

2. Comparables

The comparables method is a valuation technique that compares a company to similar companies that have been recently sold. This method is often used to value small businesses or businesses that do not have a long history.

The main advantage of the comparables method is that it is relatively simple and easy to understand. The main disadvantage of the comparables method is that it can be difficult to find companies that are truly comparable.

 

3. Asset-Based Valuation

The asset-based valuation method is a valuation technique that values a company based on the value of its assets. This method is often used to value companies that have a lot of physical assets, such as real estate or manufacturing businesses.

The main advantage of the asset-based valuation method is that it is relatively simple and easy to understand. The main disadvantage of the asset-based valuation method is that it does not take into account the company's future cash flows.

 

4. Earnings Power Value (EPV)

The earnings power value (EPV) method is a valuation technique that values a company based on its earnings power. The EPV method is based on the premise that the value of a company is the present value of its future earnings.

The main advantage of the EPV method is that it takes into account the company's future earnings potential. The main disadvantage of the EPV method is that it is based on a number of assumptions, which may not always be accurate.

 

5. Market-Based Valuation

The market-based valuation method is a valuation technique that values a company based on its market price. This method is often used to value publicly traded companies.

The main advantage of the market-based valuation method is that it is relatively simple and easy to understand. The main disadvantage of the market-based valuation method is that it does not take into account the company's future earnings potential.

 

Estimating discounted cash flow

As described above, one of the most commonly used valuation method is discounted cash flow analysis. This valuation method is used to estimate the fair value of a company by discounting its future cash flows to the present.

 

Estimated discounted cash flow

 

There are a few steps involved in estimating discounted cash flow:

1.Forecasting future cash flows: The first step is to forecast the company's future cash flows. This requires making assumptions about the company's future sales, expenses, and investment plans.

2.Discounting cash flows: The next step is to discount the company's future cash flows back to the present. This is done using a discount rate, which reflects the riskiness of the company's cash flows.

3.Calculating the present value: The final step is to calculate the present value of the company's cash flows. This is done by adding up the discounted cash flows for each year.

 

The important variables used in discounted cash flow analysis are the discount rate and the forecasted cash flows. The discount rate is used to discount the cash flows back to the present, and the forecasted cash flows are used to estimate the company's future cash flows.

The discount rate is usually calculated using the weighted average cost of capital (WACC). The WACC is the average rate of return that a company must earn on its investments to satisfy its investors.

 

The formula for discounted cash flow valuation is as follows:

Present value of cash flows = Future cash flows / (1 + Discount rate)^n

where n is the number of years into the future.

 

Discounted cash flow valuation is a powerful tool for estimating the fair value of a company. However, it is important to remember that all valuation methods are based on a number of assumptions and so there is no guarantee that the estimated value will be accurate.

 

Improving your Discounted Cash Flow estimates with real data

To improve the accuracy of your valuation, you need to minimise the assumptions as much as possible. Forecast future cash flows should be based on solid current cash flows and trends from your business operations.

 

Improving discounted cash flow estimates

 

In other words, you will need to have a solid back-up of actual current cash flows to better estimate future cash flow values.

Accounting Software from Skhokho will provide you with actual cash flow reports, derived from business invoices and other sources, tied to actual running projects with timesheets and expenses to back it up.

You can also use the historical trends to justify the rates of growth and increase in the future projections. This way when you present your business valuation reports and figures - you will have solid back-up evidence to justify the valuation you calculate.

Get started with Skhokho today and try out our accounting software for free: https://skhokho.io/authentication/register

 

How do investors evaluate my business?

There are a few key things that investors will look at when evaluating your business. They want to see a proven track record of success, a strong management team in place, and a clear path to profitability.

They'll also look at your industry and compare your company to others in the same space to get a sense of how much potential your business has.

 

How do investors evaluate my business

 

One of the most important things investors will look at is your company's financials. They'll want to see things like your revenue, margins, and burn rate.

They'll also want to understand your business model and how you make money. All of this will give them a good sense of whether or not your business is a good investment.

Another key thing investors will look at is your team. They'll want to see that you have a strong management team in place that is composed of people with the right skills and experience.

They'll also want to see that your team is committed to the success of the company and that they have a clear vision for the future.

Finally, investors will also want to see a clear path to profitability. They'll want to see that you have a solid business plan in place and that you're making progress towards your goals. They'll also want to see that you have a realistic understanding of the market and the competition.

The current industry norms and trends for investors when it comes to company valuation are always changing.

However, some recent studies have shown that investors are increasingly looking for companies that have a clear path to profitability and a strong management team in place. They're also willing to pay more for companies that are in growing industries with high potential.

 

Private equity valuation metrics

In the private equity world, there are a number of different valuation metrics that are used to determine the value of a company. The most common metric is the multiple of invested capital, or MOIC.

The MOIC is calculated by dividing the current value of the company by the amount of money that has been invested into the company. The MOIC is a good way to measure the performance of a private equity firm because it takes into account the amount of money that has been invested and the current value of the company.

 

Private equity valuation metrics

 

Another common valuation metric is the internal rate of return (IRR). The IRR is the rate of return that a private equity firm would earn if it sold the company today. The IRR is a good way to measure the performance of a private equity firm because it takes into account the amount of money that has been invested and the current value of the company.

The last common valuation metric is the multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA). The EBITDA multiple is calculated by dividing the current value of the company by the EBITDA of the company.

The EBITDA multiple is a good way to measure the performance of a private equity firm because it takes into account the amount of money that has been invested and the current value of the company.

Skhokho Business Management Software
Bertha Kgokong
Published on Aug. 23, 2022

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