There are different reasons why a business valuation is needed: selling of the business or specific portion of it, investment purposes, sale of stocks, applying for loans, and other reasons. Depending on the goal, and the size of the business, different valuation methods can be used.
Market Valuation Method
The market valuation method uses the available current sale transactions of a comparable company. This method can be favorable for a public company since the data is much more accessible but can be challenging for sole proprietorship businesses; the information is not publicly available.
Asset Valuation Method
This business valuation utilizes the balance sheet to determine the business value, which evaluates the company’s total tangible and intangible assets. It can be useful for companies that are asset intensive, which involve significant investments in machinery and equipment.
Discounted Cash Flow (DCF) Method
The discounted cash flow method uses the future cash flows discounted to its net present value, which mostly utilized the weighted average cost of capital (WACC). Many opt for this method as it seems to be a reliable approach. However, it is more complicated to use.
ROI – Based Valuation Method
The Return on Investment (ROI) – Based Valuation Method, as it implies, uses the return on investment as the basis in doing the business valuation. This approach can give a comparison of different investments. Investors also prefer this in evaluating the business since it provides a figure of how much they can earn by investing in the company.
Capitalization of Earnings Method
It is an approach that uses the normalized income streams and the capitalization rate in the computation. Mature and established businesses mostly used the capitalized earnings method.
Times Revenue Method
It is a method that uses revenue streams for a certain period and applied to a multiplier (ranges from less than one to two), which depends on the industry and economic environment. The time revenue method is used to compute the maximum value of the company. It is mostly used by new businesses or those enterprises that have volatile revenues.
Compared to times revenue method, earning multiplier is considered more reliable as it uses earnings as the basis. The earnings multiplier reflects the risk and opportunity of a company. If the risk is higher, then the earning multiplier is lower. On the other hand, the higher the opportunity, the higher the multiplier.
This method computes the value of a company if the business is sold today. It could be lower than the actual value since the liquidated company is priced lower than the market value.
Rather than choosing one of the methods, it is best to utilize the combination of the approaches depending on the business at hand to give a more reliable valuation. You can visit eFinancialmodels for available financial models in plotting and preparing the business valuation.