How to value your business?
There are several ways to determine the value of your business.
- Asset based approach
Asset based valuation is the form of valuation in business that focuses on the value of the company’s assets or the fair market value of its total assets after deducting liabilities. Assets are evaluated and the fair market value is obtained. The key here is determining fair value, especially of assets since fair value may differ significantly from acquisition value (for non-depreciating assets) and recorded value (for depreciating assets).
There are two types of asset: tangible and intangible. Tangible assets are the physical things belonging to your business, such as your business premises, stock, land and equipment. Intangible assets are any non-physical assets, such as your business brand, reputation and intellectual property including copyrights and patents.
To get the Net Book Value (NBV) of your business, you subtract the costs of your business liabilities (such as debt and outstanding credit) from the total value of your tangible and intangible assets. Things which you never paid for may form part of the value, as would a unique way of doing business that gives your company an advantage.
Balance sheet figures can’t be equated with value due to historical cost accounting and the principle of conservatism. Simply put, relying on basic accounting metrics doesn’t paint an accurate picture of a business’s true value.
- Discounted Cash Flows
Discounting future cash flows is a quantitative business valuation method. Business owners use information from the company’s income statement to value their company. Companies usually report their earnings as income before interest, taxes, depreciation and amortization (EBITDA). This number is essential for valuing a company using the discounted cash flow method.
Business owners must forecast future years’ EBITDA when using the discounted cash flow method.
Discounted Cash Flow = Terminal Cash Flow / (1 + Cost of Capital) # of Years in the Future
The benefit of discounted cash flow analysis is that it reflects a company’s ability to generate cash. However, the challenge of this type of valuation is that its accuracy relies on the terminal value, which can vary depending on the assumptions you make about future growth and discount rates.
- Market Capitalization
Market capitalisation is the total value of all outstanding shares of the company’s stock. It is calculated by multiplying the stock’s current share price and the number of shares outstanding.
Market capitalization provides an idea of the size of the business and makes it easy to identify peers within a sector.
Market capitalization demonstrates that share price alone tells you little about a company’s overall value. Just because a stock has a high share price does not necessarily mean the company is worth more.
Market capitalization omits some important facts in the overall valuation of a company. Most importantly, it does not take into consideration the company’s debt.
To calculate enterprise value, add the company’s market capitalization to its outstanding preferred stock and all debt obligations, then subtract all of its cash and cash equivalents.
- Enterprise Value
The enterprise value is calculated by combining a company’s debt and equity and removing the amount of cash it’s currently holding in its bank accounts (since it’s not part of its actual operations).
Enterprise value can be calculated by adding debt to equity and subtracting cash.
Enterprise Value = Debt + Equity – Cash
Example: Suppose consider a company had a market capitalisation of ₹51 Crores, its balance sheet showed liability of ₹13 Crores. The company also had about 5Crores in Cash in its account, giving an enterprise value of ₹59 Crores. (i.e. ₹51Crores + ₹13Crores – ₹5Crores = ₹59Crores)
- Entry valuation
An entry valuation framework model values a business by working out how much it would cost to establish a similar business. Essentially, it’s asking “if my business didn’t exist, how much money would it cost to start it from scratch, right now?”
A good way to get an accurate estimate is to create a list detailing start-up costs, the price of acquiring tangible assets, employing and training staff, establishing a customer base, and developing products and services.
You might be able to save some of your hard-earned cash if you set up your business in a cheaper location or opt for more cost-effective equipment. After working out these savings, subtract them from your projected start-up costs.
- Present Value of a Growing Perpetuity Formula
A growing perpetuity is a kind of financial instrument that pays out a certain amount of money each year, which also grows annually. Imagine a stipend for retirement that needs to grow every year to match inflation. The growing perpetuity equation enables you to find out today’s value for that sort of financial instrument.
The value of a growing perpetuity is calculated by dividing cash flow by the cost of capital minus the growth rate.
Value of a Growing Perpetuity = Cash Flow / (Cost of Capital – Growth Rate)
So, if someone planning to retire wanted to receive ₹6,00,000 annually, forever, with a discount rate of 10 percent and an annual growth rate of 4 percent to cover expected inflation, they would need ₹1,00,00,000 the present value of that arrangement.