Valuation methods for your company
Valuation methods for your business
In practice we separate the types of valuation models into a few categories. We will give an overview of these categories first and then describe the individual valuation models within each category. In practice, we can help you with doing a very concise or detailed valuation. A concise valuation would just be a quick check to get a first indication to see if the valuation you have in mind can be achieved in the market. In the end, the market determines the price you will get for your business. This price differs from the valuation of your company. The other option, which we prefer, is to conduct a detailed valuation model that is specifically made for your business and takes into account the unique features of your company.
The main valuation categories are:
- Balance sheet-based on valuation methods
- Income statement profit and loss (P&L) related valuation methods
- Cash flow-based valuation methods
- Other types of valuation methods
In practice, we base our valuations on various methods.
Balance sheet-based valuation methods
Balance sheet-based valuation methods are based on the balance sheet of a company. These are the most straightforward valuations. One disadvantage is that they do not take the earnings capacity of the company into account, which is what most buyers are interested in. Another disadvantage is that these valuation methods are not forward-looking. They are based on the historical performance of the company.
An overview of balance sheet-based valuation methods:
- Book value
- Adjusted book value
- Liquidation value
The book value method mainly looks at the current equity of the company. It deducts all the liabilities from the total assets and the difference is the book value of the company. To get to this value one can also look directly at the equity of the company. This method is, of course, dependent on the accounting principles a company has used in the past. A disadvantage is that this method does not take into account the market values of certain assets. For example, a company might have written down its trucks and trailers for accounting purposes. Hence, in the official accounts, these trucks have a low value. This does not reflect the actual prices of these assets in the market. The adjusted book value marks up all assets (and also the liabilities) to current market values. In this way, the balance sheet is prepared again but now with the restated market values. Once this is done, the total liabilities are subtracted from the assets. The remaining difference is the adjusted book value, which is the valuation of the company.
The liquidation value is limited to a highly specific situation, namely when the company is planning to be liquidated. This is basically the lowest value a company has, as it is mostly the last alternative a company will use. The liquidation value of the company is the company’s value if it is liquidated, that is, its assets are sold, and its debts are paid off. This value is calculated by deducting the business’s liquidation expenses (redundancy payments to employees, tax expenses, and other typical liquidation expenses) from the adjusted net worth.
Income statement (P&L) related valuation methods
Income statement related valuation methods are often based on multiples. These multiples can be based on EBITDA (or profit before tax). EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA multiples can range from 3 to 7, but occasionally we see higher valuations as well. This depends very much on the type of industry, growth perspective of the company, length of contracts and many other variables. Hence, it is exceedingly difficult to judge which multiple your company should sell for without doing a detailed analysis of similar players in the market, understanding the industry dynamics, etc. We are happy to discuss this in more detail with you and give honest feedback on the value we think is appropriate for your company.
Cash flow-based valuation methods
The main cash flow-based valuation method is the DCF (discounted cash flow method). This methodology brings all future free cash flows back to the current moment. All these free cash flows are discounted at a certain discount factor which compensates for the time difference between the future period when the cash gets in and the current period. Our valuation experts have special models where all the variables can be inserted after a detailed investigation of the company has been done. The end result is a valuation of the company based on future cash flows.
The discount factor being used is often the weighted average cost of capital (both equity and debt). The discounted cash flows can be compared with the current cost of the investment to see if the investment opportunity is a good one. In theory, the cash flow-based valuation methods are good as they look at the future and look at the free cash that is being generated. A disadvantage is, like many methods, that the valuation depends on the data inserted in the model and the accuracy of the numbers which is often only known with hindsight.
Other types of valuation methods
There are several other valuation methods, but many are related to the ones mentioned above. The economic value analysis is another valuation model that can be used. This methodology compares the value at two different periods in time and looks at the difference to explain which value has been added by the management.
Real options analysis is another valuation method. This relies on cash flows but is grounded in option-pricing models instead of DCF models. Real options analysis is hardly ever used to value an entire company. This valuation method proves useful when a company has investment opportunities that have option-like features. These option-like features are usually difficult, if not impossible, to capture using DCF models
Information about valuation methods
We have advisers that speak your native language and have experience with optimizing companies for a business sale. We are happy to share this knowledge and give you some free consultation on what to consider when optimizing your company for a business sale. Do you want to get support in increasing the value of your company today? Feel free to contact us.
Valuations are a small but important part of the M&A process, perhaps you would like to see the whole perspective? The pages below can give you better insight and can direct you to other in-depth information.