Valuation analysis is a process done with the aim to find out the approximate value or worth of an asset, whether it's a business, equity, fixed income security, commodity, real estate, or any other asset. The analyst uses different approaches and methods to do the valuation analysis for different types of assets, this common practice is meant to be looking at the underlying fundamentals of the asset.
Investing money in a reputed firm is a good practice, this investment not just saves your money for future purposes but also promotes your money in the market and increases its value with the value of the company in which you have invested. But investment is not that easier, it encompasses a number of complications and risks.
Before investment, an investor must know the value of the company to decrease the chance of money loss. The value of the public entities are well known to everyone, but the value of a private firm is not known to everyone this is because private companies generally do not expose their valuation. Let us know what is the meaning of the valuation and how does it help an investor?
So, a valuation of a company helps investors in recognizing its financial strength, success, and progress. It also helps in tracing the performance of a company in the market. By knowing the valuation of a company, investors can easily decide where they can invest or how much investment would be safer in which company.
Why do you do the valuation of a company?
Estimating the fair and appropriate value of a business is an art and a science not everyone can do this easily; there are several formal methods that can be used, but choosing the right one is essential but and then, the appropriate inputs could be somewhat subjective.Calculating the worth of a company is extremely important not just if you are buying or selling; but for a few more reasons doing the valuation of a company is essential, they are mentioned below:
- If you are looking for financing lenders, venture capitalists, or investment bankers.
- In case, if two persons are in a partnership, and one partner wants to sell his shares so knowing the partner’s share is very important.
- In the case of divorce, if and husband-wife are a partner in a company then they have to know the shares or assets so that they can divide assets equally into two parts, etc.
How to do the valuation of a company?
Valuation is most important for tax reporting. The Internal Revenue Service (IRS) wants that a business should be valued on the basis of its fair market value. Some other tax-related events such as the purchase, sale, or gifting of shares of a company would be taxed depending on the valuation.
The process of a company or a business valuation comes in a series of steps one ascended by another, there are basically 6 essential ways involved in the valuation of a company, and they are mentioned below:
- The easiest step to evaluate the value of a company is: Subtract the liabilities from the assets.
- The next method is to find its book value, by using data mentioned in the balance sheet. To know the book value, simply subtract the liabilities from its assets and exclude all intangible assets and you will be left with the accurate tangible assets of the company.
- Market capitalization is another simple way to do a company valuation, one can calculate it by multiplying the total number of shares by the current share price.
Market capitalization = share price x the total number of shares.
- Another method for company valuation is discounted cash flows, in this process, one can evaluate the value of a company or an investment based on cash flows.
Discounted cash flow = terminal cash flow/ (1 + Cost of Capital) # of Years in the Future.
This method makes you know about the ability of a company to generate liquid assets.
- The enterprise value is another way of evaluating the value of the company, it is calculated by combining the debt of the company and its equity and then subtracting the unused cash.
Enterprise value = debt + equity - cash.
- EBITDA (earnings before interest, taxes, depreciation, and amortization) is a good method used to know the value of a company especially to know the profit on net income. It is calculated by adding interest, tax, depreciation, and amortization expenses to net income.
EBITDA = OPERATING INCOME+ DEPRECIATION.
- The present value of growing perpetuity is a good method to take an overview of the company’s valuation, it is calculated by dividing cash flow by the cost of capital minus the growth rate.
Value of growing perpetuity = cash flow / (cost of capital - growth).
A growing perpetuity is a kind of financial tool that pays out a fixed amount of money every year, which grows annually. Suppose, the stipend money for retirement has to grow every year to match inflation. The growing perpetuity equation enables you to find out today’s value for this kind of financial tool.
- Liquidation value is the value in terms of net cash that will be received by a business if its assets are liquidated and liabilities are paid off.
There is an elongated list of ways of evaluating the value of a company, few are mentioned below in detail and a few that are not much in use and are not general are, replacement value, break-up value, asset-based valuation,and still many more.
Bonus Tips: Some easy steps to value and evaluate a company before making any investment
- Take the service from the business professional.
- Then understand the purpose of doing valuation.
- Consider the type of value and determine its basis.
- Make a premise of a deal.
- Collect the relevant data.
- Take an overview of the historic background of a company or a business.
- Take a future outlook and overview of a business.
- Select the appropriate valuation approach.
- Apply for discounts or bargaining.
- Reach the determination of value or fixed the price.
Whether you’re looking to borrow money, sell a portion of your company, or anything else firstly understand the value of a company and then be determined for any investment. Doing the valuation of all the assets and liabilities of a firm is the simple step to a healthy and safe investment. And if you are new to the task of investment then take the help of a valuation expert for the company valuation in which you are willing to make an investment. Last but not least, investment is an art of patience. So be patient and take a close overview of every factor before investing.