Understand what business valuation is, its various applications and details that can make the business worth more!
The answer to this question is essential in many situations. Purchase and sale transactions are the most well-known, but entrepreneurs do not always know exactly what their company is worth.
Many times they even have an estimate, but it is not precise enough to defend it in the market. And anyone who thinks that the calculation of a company’s value is based solely on its revenue or net worth is mistaken .
Determining the real value of a company goes far beyond this and requires a specialized process called business valuation .
Want to understand this process better? Then check out this article in which we explain what business valuation is, its various applications and details that can make the business worth more!
What is business valuation?
Business valuation is the process of determining the value of a company using specialized methods capable of calculating the fair value of the business. The technical name for this process is economic-financial evaluation and its equivalent term in English is valuation .
In general, healthy companies are valued based on the wealth they will produce in the future and not just on their current income. The company valuation method that allows this calculation is Discounted Cash Flow (DCF) .
First, cash flow projections are made for the future based on the company’s growth rate based on its historical results.
However, the DCF also considers the income that the company will have over time, after this initial period. This is called the perpetuity value or residual value.
Secondly, these projections are brought to present value by applying a discount rate. This is what allows us to know how much this future potential is worth today, after all, this rate represents the cost of capital to foster growth and, therefore, the business risk.
The value is determined by adding the present value of the future cash flow and its perpetuity.
It is even possible to apply different discount rates to determine a value range that represents the optimistic, conservative and pessimistic scenarios for the business.
Relevance of FCD
This is one of the most relevant and market-recognized methods for evaluating a company, as it considers value from a broad perspective – and because it assesses the wealth that the company will produce based on its own operational potential, albeit within the context of its market.
This method therefore considers the intrinsic value of the company. And, more than that, the evaluator can present strategic suggestions to foster the company’s growth since the DCF analyzes its key areas.
More methods of determining value
Valuation is also carried out by comparison with other similar businesses using the Multiples or Comparative Transactions method .
Relative or multiple assessment determines value by comparing indicators of the company being assessed with similar companies, whose data is publicly traded on stock exchanges in emerging countries. EBITDA is the main indicator for this type of assessment.
The calculation by Comparative Transactions uses as a parameter the sales value in the market of similar companies. It is common to use these methods in conjunction with Discounted Cash Flow.
There are also methods for evaluating companies with economic and financial problems such as Equity Value – or Book Value – and Liquidation .
What is the purpose of company valuation?
The best-known application of business valuation is in business purchase and sale transactions.
In these cases, knowing the value allows the deal to be closed in an equitable manner for both sides, the seller and the buyer. And the valuation can help attract investors as it provides greater security about the business’s situation and prospects.
However, there are many other situations in which it is useful to do a valuation. These include, for example:
- Change in company structure: in this case, we include two situations.
The first is the addition of new partners to the company in a partial purchase and sale transaction. In this situation, the valuation helps to estimate the ideal value of the shares.
This provides transparency to the new business partnership, although, of course, it does not dispense with other measures, such as a Shareholders’ Agreement , for example.The second situation is the opposite of this. It is a company division, in which case knowing the value can minimize disagreements between the partners. - Division of assets and inheritance: as with the division of a company, knowing the value of the company gives equity to the division in the event of marital separation or even death, and can reduce the natural discomfort in these circumstances.
- IPO and investment in shares: the company’s valuation estimates the initial value of shares for sale on the Stock Exchange, in IPO processes – Initial Public Offering.
- Management tool: value can be the key indicator for analyzing a company’s performance over time. Value-based management begins with an assessment of the company.From there, new goals are established for a given period. After this period, a new valuation is carried out to measure the increase in value.
- Negotiating bank benefits : the company valuation report can help negotiate benefits with banks by demonstrating the solidity of the business.There are cases in which the entrepreneur managed to obtain a 10% reduction in the interest rate for a bank loan after proving the solidity of his company through the valuation report.
Conclusion
In short, in this article, we talk about what business valuation is and the importance of valuation for any business. We detail several of the most common applications of value assessment and also indicate the enormous importance of good financial management to qualify the assessment of value.