What you'll learn:
➤ What Is a Business Valuation?
A business valuation, often referred to as a company valuation, is the process of assessing the economic value of a business.
This comprehensive evaluation covers all aspects of the business to determine not only its overall worth but also the value of its individual departments or units.
A company valuation serves various purposes, such as establishing the fair market value of a business for multiple reasons.
These include determining its sale value, settling partner ownership disputes, addressing taxation matters, and even in divorce proceedings. To arrive at an unbiased estimate of a business’s value, owners frequently seek the expertise of professional business evaluators.
Highlights
- Business valuation involves assessing the economic value of a business or its constituent units.
- This process finds application in various scenarios, including determining a business’s fair market value, resolving partner ownership issues, dealing with taxation matters, and handling divorce proceedings.
- Multiple methods are available for valuing a business, encompassing approaches like analyzing its market capitalization, considering earnings multipliers, or evaluating its book value, among others.
| Method of Valuation | How to Apply These Methods |
|---|---|
| Market Capitalization | Multiply the share price by the total number of shares outstanding. |
| Times Revenue Method | Apply a revenue stream over a period to a multiplier based on industry norms. |
| Earnings Multiplier | Use earnings to assess the company’s financial success compared to competitors. |
| Discounted Cash Flow (DCF) | Project future cash flows and adjust for present value, considering inflation. |
| Book Value | Calculate shareholders’ equity by subtracting total liabilities from assets. |
| Liquidation Value | Determine the net cash if assets were liquidated and liabilities paid today. |
➤ The Basics of Business Valuation
Business valuation is a hot topic in corporate finance. You often hear about it when a company wants to sell part or all of its business or when it’s thinking about merging with or buying another company.
So, what’s it all about?
Valuing a Business: Business valuation is like figuring out how much your car is worth before you sell it. It’s the process of finding out how much a business is worth right now. We use some pretty solid methods and check every nook and cranny of the business to do this.
What We Look At: When valuing a business, we look at everything from how it’s managed to how it’s financed. We also check what it might earn in the future and what its stuff (assets) could sell for in the market. It’s like giving the business a full health check.
Tools We Use: Valuation tools can be different for every business and industry. It’s like a toolbox, and we pick the right tools for the job. Some common tools include looking at financial statements, doing fancy math with cash flows, or comparing the business to similar ones.
Tax Time: Valuation isn’t just for selling or buying businesses; it’s also a big deal for taxes. The IRS (the tax folks) says we need to figure out a business’s fair market value for tax purposes. So, when people buy, sell, or gift business shares, taxes can come into play based on this value.
Art and Science: Valuing a business is both an art and a science. There are formal models and methods we use, but there’s also some subjectivity involved. Picking the right method and using the right numbers can sometimes feel like an art form.
In a nutshell, business valuation is like figuring out how much your business is worth, and it’s essential for many business deals and tax situations.
➤ Methods of Valuation
There are several approaches to determine the value of a company. These methods provide a variety of perspectives on a company’s value.
It’s worth noting that this list doesn’t cover all the business valuation methods in use today; others include replacement value, breakup value, asset-based valuation, and more.
Below, you’ll discover a range of these methods:
1️⃣ Market Capitalization
Market capitalization is one of the most straightforward ways to assess a business’s worth. It’s calculated by multiplying the company’s share price by the total number of outstanding shares.
For instance, as of January 3, 2018, Microsoft Inc. was trading at $86.35.
With a total of 7.715 billion shares outstanding, the company’s valuation could be calculated as $86.35 x 7.715 billion, which equals $666.19 billion.
2️⃣ Times Revenue Method
The times revenue valuation method involves applying a multiple to a stream of revenues generated over a specific period.
The multiplier used depends on the industry and economic conditions. For example, a tech company might be valued at 3x revenue, while a service firm could be valued at 0.5x revenue.
3️⃣ Earnings Multiplier
Instead of the times revenue method, the earnings multiplier is used to provide a more accurate assessment of a company’s true value.
A company’s profits are often considered a more reliable indicator of financial health than sales revenue.
The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period, effectively considering the present value.
4️⃣ Discounted Cash Flow (DCF) Method
The DCF method of business valuation is akin to the earnings multiplier. It relies on projections of future cash flows, adjusted to determine the current market value of the company.
The primary difference between the discounted cash flow method and the profit multiplier method is that DCF accounts for inflation when calculating the present value.
5️⃣ Book Value
This figure represents the value of shareholders’ equity, as indicated on the company’s balance sheet statement. The book value is determined by subtracting the company’s total liabilities from its total assets.
6️⃣ Liquidation Value
Liquidation value quantifies the net cash a business would receive if its assets were liquidated, and all liabilities were settled immediately.
➤ How to Receive Accreditation in Business Valuation
In the United States, the Accredited in Business Valuation (ABV) is a prestigious professional designation bestowed upon accountants, notably Certified Public Accountants (CPAs), who specialize in assessing the value of businesses.
This certification is regulated by the American Institute of Certified Public Accountants (AICPA) and entails a thorough qualification process. Here are the key steps:
- Application Process: Candidates must initiate the process by submitting an application.
- Examination: A comprehensive exam is administered to assess the candidate’s knowledge and expertise in business valuation.
- Business Experience and Education Requirements: Candidates need to meet specific criteria related to their professional experience and educational background.
- Credential Fee: A credential fee is required for obtaining the ABV designation. As of March 11, 2022, the annual fee for the ABV Credential was $380.
Holders of the ABV designation are also obligated to maintain certain standards throughout their careers. This includes ongoing work experience and lifelong learning requirements.
Acquiring the ABV designation can have several benefits for professionals, such as enhancing job prospects, bolstering their professional reputation, and potentially leading to higher compensation.
In Canada, a parallel professional designation for business valuation specialists is the Chartered Business Valuator (CBV).
This designation is conferred by the Canadian Institute of Chartered Business Valuators (CICBV).
Both the ABV and CBV designations signify a high level of expertise and proficiency in the field of business valuation.
➤ References
- Internal Revenue Service. “Sale of a Business.”
- Yahoo Finance. “Microsoft Corporation (MSFT).”
- Association of International Certified Professional Accountants. “Distinguish Yourself. Obtain the Accredited in Business Valuation (ABV) Credential.”
- Association of International Certified Professional Accountants. “AICPA Annual Membership Dues.”
