Suppose somebody stops you on the street and asks you how much your business is worth. How do you respond? You could probably provide some information that would offer a semblance of an answer, like how the stock is currently trading or how much revenue you expect in the near future. With the market being as volatile as it is, however, do these numbers actually encapsulate the intrinsic value of your company?
This is why valuation advisory services are so beneficial. It accurately determines the value of your company. It can also calculate how much your assets are worth and determine whether they were worth the investment. The most prudent business owners have outside organizations conduct valuation advisory for them, especially since the results can be quite noteworthy for potential investors. Savvy entrepreneurs have an understanding of valuation advisory services and how they can use that information to better their enterprise.
What Is Valuation?
In basic terms, valuation is the process in which the worth of a company, or its assets, is measured. There is a multitude of ways to do this. That being said, the gist is that the company’s assets, liabilities, stock price, and projected earnings are compiled and entered into one of several formulas to extrapolate a single figure that indicates the overall worth of a company.
In the case of assets, the projected revenue is taken into account to determine how valuable each is to keep around. This often uses fundamental analysis (which takes in a cumulative amount of data, including the current market conditions and business management) to identify the value of a given security.
The price to earnings (P/E) ratio also importantly informs any valuation. This ratio essentially compares the price of a company’s share to its earnings per share (EPS). The figure is literally found by having the share price divided by the EPS. Determining the P/E ratio can help determine the value of the company’s shares.
Methods of Valuation
All valuation advisory employs highly-advanced mathematical functions to arrive at the net worth of the given company. There are several different methods, each with their own formulas that are really only comprehensible to those with accounting degrees. However, every method falls into three categories, which are much easier to digest.
This might be the simplest method. Asset-based valuation is conducted by accumulating the entire mass of assets a company owns, or each asset’s current market value, and subtracting the liabilities to figure out the net value of the company. Taking into account the current market value of an asset is critical, especially with assets that were acquired long ago. Over time, other assets are developed that are either less costly or more productive, which scales the end result of valuation. Outside investors are always more concerned with an asset or company’s worth in today’s market conditions.
This form of valuation is not always ideal but can be quite beneficial to certain businesses. Companies that sell products and manage inventory might appreciate comparing their assets with their liabilities. This, of course, applies heavily to retail businesses.
Suppose that, instead of a product-selling business, you own a company that provides a service. Lacking many tangible assets, an asset-based valuation is inappropriate. In this case, earnings-based valuations are more desired, since they are more concerned with projected cash flow than assets and liabilities. In such a method, the earnings of a company in the near future are compiled, taking into account the stock price, to determine the company’s worth.
The two main operations that accomplish this aim are discounted cash flow (DCF) analysis and the dividend discount model (DDM). DCF works by looking at the projected income of a business over the next five years using a discounted rate. These projections are punched into a formula that calculates the value of the company in the upcoming future.
DCF yields a very valuable figure for potential investors. This figure is often considered when looking at the market price stock is trading at. Typically, if the worth of a company found with DCF analysis is higher than the current cost, it is deemed a fruitful investment. Otherwise, it may take a lot of convincing for someone to invest in your company.
DDM is similar in many ways to DCF but, rather than analyzing projected cash flow, it looks at the amount of dividends paid to the company’s shareholders. The logic behind DDM is that calculating dividends paid out is more accurate to indicate the company’s worth. The calculation from DDM also interests potential investors if it is worth more than the cost of the stock.
This form of valuation differs from the other two in that it compares the company being valued to similar companies. Usually, relative valuation looks at certain statistics that are shared between all companies (e.g. P/E ratio) to see what an asset or company is worth compared to the rest of its sector.
The most common use of relative valuation is through comparative company analysis. With this, it is ideal to look at companies with a similar size to the subject company. Comparative company analysis calculates the P/E of a business, as well as EV/sales (enterprise value divided by sales), price/book ratio (the price of a stock compared to the assets divided by liabilities of a company), and many other stats to see how the company compares to its contemporaries.
While very effective in some cases, market value can be difficult to evaluate for certain industries. At times, a business can sell a little lower than usual due to poor management, low EBITDA (earnings before interest, taxes, depreciation, and amortization), and several other factors. This can skew the numbers for a company looking to find how it truly compares to competitors.
Why Use Valuation Advisory Services?
Valuation advisory can have many subjective implications. Knowing the value of your business can be useful in so many cases that—even if it doesn’t address an immediate need—it will likely come in handy at some point down the line.
Selling a Business
Perhaps the most popular purpose of valuation advisory is to find an appropriate price to sell your business. Not only does valuation advisory services provide a recommendation of how much to ask for the sale of your business, but it also attracts potential buyers. An exact value is much more appealing to someone looking to buy a business than projections or speculation about its worth.
Attracting Potential Investors
Very few things in the stock market are as intriguing as the promise of long-term profit from a business. Certain methods of valuation, like DCF analysis, calculate future performance for a business, which can raise investors’ interest. A promising DCF, which projects revenue for five years, lets the investor know that holding on to their share will provide dividends. This knowledge can be more valuable than a nice ABC chart or records of a previous well-performing quarter.
Negotiation During a Merger or Acquisition
In today’s business world, mergers and acquisitions are a common occurrence. Just look at Disney, who bought Lucasfilm and 21st Century Fox within the past decade. If the day comes that a large conglomerate offers you something for your business, it is in your best interest to have an accurate reading of its net worth.
Defense Against Undervaluing
During negotiations such as the mergers discussed above, it is a real possibility to undervalue your business. While most companies put in some effort to give a fair price, owners often sell their businesses for less than their values. At the end of the day, the buying party wants to spend the least amount of money possible for the sale and will negotiate to that end. Doing valuation advisory is an effective way to prove to potential buyers that your business is worth a certain amount.
If valuation advisory is not done, other parties might make their own estimates as to how much someone should pay for your business—and it may not be to your liking.
Say, for example, someone wants to buy your business. That person goes to the bank to take out a loan to make the purchase. If the business in question did not have valuation advisory done, the bank will evaluate the worth of the business through its own means. As a result, the owner might leave the negotiating table with less than what they could have gotten. In general, any potential buyer might try to do their own valuation, or at least estimate the company’s worth, but these figures may be inaccurate.
Backup in Unforeseen Events
Nobody likes talking about it, but unexpected events and crises happen in business all the time. Getting a valuation advisory can arm a business owner for negotiations they might otherwise go into ignorant. Disaster invites outside parties to come and try to buy parts or the whole of a business. It is important, in these negotiations, to be armed with correct information concerning assets and the company’s worth to be able to better barter.
Making Business Decisions to Save Money
An oft-understated benefit that comes from valuation advisory is the information it provides to owners who don’t want to sell their businesses. Knowing the company’s value can confirm whether it is paying out as they hope.
Using valuation for assets can also be a great help for business owners. A high value provides owners with information about which assets bring in the most revenue. Conversely, a low value helps identify whatever liabilities are too costly for the business and could be replaced. Either way, owners gain insight and information on how the company is performing—and that is always valuable.
Valuation Advisory Done for Tax Purposes
Valuation advisory also aids business owners in planning for taxes. Certain forms of income—if categorized properly—are taxed less than they would be if declared in another category. An example of this is deeming incentive programs for employees as capital gains, rather than ordinary income. In such cases, a business can save a little bit of money. Valuation advisory uncovers similar pieces of information about a company’s assets that can affect how they are taxed.
Is Owning Business Worth It?
There are the owners that are on the fence about whether to sell their business. Valuation advisory services can inform decisions on whether the profit from a business is worth the cost of its operation, or if it is more sensible to sell. This helps business owners who put their own wealth into their businesses to determine how much to reinvest into the company.
This applies more to entrepreneurs who own multiple businesses. Though these owners may have a primary company that provides their main income stream, they also might run a small side business for extra revenue. With valuation advisory, the owner can determine whether the endeavor is worth it, or whether selling it is the greater prospect. An accurate grasp of the value of your company is very important information to have in this day and age, especially since the market is so unpredictable. The numbers don’t always perform the way your projections said they might. Valuation advisory is the most reliable way to determine how much your business and/or assets are worth. It is a standard practice all businesses follow at some point.