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business valuations
November 18, 2022 / IntelekSiteAdmin / 0 Comments

HOW DO I VALUE MY BUSINESS?

How do I Value My Business? Within industry-accepted frameworks, there are three
main valuation approaches, with each approach having various valuation
methodologies within it. We’ll keep this article simple, while giving you the
insight into how you can view your business in relation to the valuation
process.

For the most complete and robust valuation process, all three approaches must be
executed. However, depending on the specific factors of the business, one or
more methodologies will be better suited or applicable.





THE ASSET APPROACH

You may have heard this: “Take all the business’ assets and minus all the
business’ liabilities.” Basically, this statement refers to what you see in the
equity section on your balance sheet. But this is not accurate.

Asset-based valuation, in simple terms, is finding the current economic value of
all assets, minus the current economic value of all liabilities. In other words,
 the current economic value of each asset and liability may not be what is
currently stated on the balance sheet. An example is a motor vehicle that has
been depreciated beyond its current market value (taking advantage of the
depreciation thresholds for tax purposes).

As previously mentioned, the specific approaches can be more or less applicable
depending on the case facts. If the subject business is going to be liquidated,
then often the asset-based valuation is the preferred methodology, as there is
no future income or profits to consider. Liquidation again will have an impact
on the current economic value of the assets, as they will most likely be
discounted to sell fast, as with a fire sale, for example. When the business is
profitable or has reasonable growth prospects, this value is often not captured
on the balance sheet and, therefore, not captured under the asset-based
approach.

For many companies, intangible assets make up a sizable portion of the balance
sheet, and can be very difficult for laypeople to calculate on their own.
Software, data, and similar companies rich in intangibles often call in
valuation experts for assistance.





MARKET APPROACH

Market approach means comparing other companies that are similar enough to the
one being valued.

The easiest way to think of this in perhaps the most common market is in terms
of property and housing. The asset’s value is largely determined by the price at
which similar assets in the local area most recently sold for (the similar
three-bedroom, two-bathroom house on the same-sized block on your street that
sold for X amount last month, for example).

For privately held businesses, valuation appraisers will use a few different
methods at their disposal and, again, apply the most applicable depending on the
available data and case facts:

 1. If the business has gone through a recent round of funding (offering of
    equity/shares in the company to an unrelated third-party investor), this
    would demonstrate a recent transaction of a similar or exact-same company
 2. Private company transactions – finding recent transactions from various
    databases of private company transactions that are similar enough to the
    subject company.
 3. Public company transaction – finding recent transactions from various
    databases of public company transactions that are similar enough to the
    subject company

(For point 3 above, this value information is readily available due to
regulatory requirements, and helps lift the veil that often makes large-scale
private company valuation difficult.)


EARNINGS OR INCOME APPROACH

Finally, valuation with income is a way to account for future cash inflows.
Identifying how much earnings (profits) the company will generate into the
future and valuing those future profits as of today (meaning the present value).
This is most often seen when considering an investment, as the assets themselves
aren’t of concern—only their ability to generate excess returns.

In this approach, there are two main methodologies:

 1. The discounted economic income (discounted cash flow), in which the future
    earnings are projected along a time horizon of often 3-5 years. This is done
    to capture the expected changes in cash flows to the historical ones
    (growth, decline, or both). This is then combined with other variables and
    added to a terminal value, which measures a continued steady-state growth
    into perpetuity, and discounted to the present day. This discounted process
    uses a Cost of Capital method. A primary downside to this method is that
    it’s as much art as science, and it’s subject to many variabilities.
    Changing economic conditions, slower-than-expected growth, increased costs
    in an area, and other variables and predictions can increase model risk and
    skew a valuation.
 2. The capitalization is derived from the Cost of Capital method, which uses a
    single measure of sustainable cash flows identified from the historical
    financial performance of the business and projects it into the future. To
    arrive at the business’ value, this identified number is then capitalized
    based on its risk profile.


CONCLUSION

How Do I Value My Business? Each approach and method have its place and benefit,
and it’s typically best to use a mix of the three for analytic purposes. This
simple explanation will give you a different perspective when examining your
business and setting its valuation goals. However, as you can imagine, the
complexity of the methodologies and required detail dramatically expand
depending on the valuation purpose, such as tax compliance or litigation in
which the valuation needs to be extremely defensible.

#asset approach #business valuation #Business valuations #how do I value my
business #income approach #market approach


Author

INTELEKSITEADMIN





DEFINITION AND MEANING OF A BUSINESS VALUATION

November 18, 2022

COST OF CAPITAL METHODS

December 26, 2022

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