If you run a company, your company’s valuation can play a role in your ability to raise funds from investors. If you’re trying to sell your company, potential purchasers will likely use its valuation in order to assess how much they’re willing to pay to buy it from you.
Just like many other investment concepts, there are several methods used to work out the value of a company or other asset. We’ve gone into greater detail on these methods below, as well as the basics of the valuation process.
What is Valuation?
Valuation is the process of working out how much a company or asset is worth. It’s a subjective calculation that approximates the present value (PV) of a company asset a specific point in time based on current conditions.
In order to calculate a company or other asset’s value, investors, lenders and other parties use a range of different valuation methods.
Valuations are used for a wide range of purposes. While they’re most commonly used in order to calculate the value of a company for investment or purchase, they’re also carried out to work out the value of specific assets for tax purposes, for litigation, or for analysis or financial reporting.
Investors and analysts use a range of different valuation methods to value companies and other assets. We’ve listed some of the most common valuation methods below, along with information on how these methods are typically used.
Why Valuation Matters
While it might not seem important to work out your company’s value, having an understanding of how much your company is worth has several advantages.
First, understanding your company’s value can make it easier to raise funds in the future. This is important if you plan to grow your business and need access to investment capital to open new locations, develop new products or market your business.
Second, by understanding your company’s value, you can start to think long-term about the best direction to move in. You might start to aim towards a certain target valuation before selling your business, or consider acquiring a competing business to increase your company’s value.
In short, while valuation isn’t everything, it can be very helpful to understand approximately how much your business is worth.
Common Methods of Valuation
There are countless different methods used to value companies and other assets. However, for large companies, analysts tend to us four different methods to determine the company’s present value:
Discounted Cash Flow Analysis (DCF). This method uses the time value of money to value a company or other asset. Using this method, analysts attempt to find the present value of a company’s expected future cash flows in order to value the company.
Precedent Transaction Analysis. This method, which is also known as “M&A comps”, values a company based on the previous prices paid for similar companies that have been acquired.
Comparable Company Analysis (CCA). This method values a company by analysing the metrics of similar companies in the same industry. By comparing one company to its peers based on factors such as cash flows, analysts can calculate its approximate value.
Leveraged Buyout Analysis (LBO). This method uses the cost of buying a company via leveraged buyout to calculate its value. Public companies can be acquired through purchasing a controlling share on the stock exchange.
These methods are typically used to value large, publicly traded companies. To value smaller companies and assets, analysts and investors might look at factors such as the income that’s earned by the company annually vs. its operating costs or its assets and liabilities.
The larger and more complex a company is, the more challenging it can often become to reach an accurate valuation.
The Limitations of Valuation
It’s important to remember that the value of a company reached though valuation isn’t an exact or permanent figure.
For example, an investor interested in purchasing a company might have a valuation performed on the business. The valuation might find that the business is worth £1 million at the time of the valuation.
If, over the next year, market conditions change and the company’s growth slows down, it might be worth less than its previous valuation. On the other hand, if market conditions improve or the company improves internally, it could be worth more than its previous valuation.
Valuation is an important process that can help you (or an outside analyst or investor) calculate how much your company is worth.
Like many other financial figures, valuation is subjective, meaning you might reach a variety of different valuations by using different methods. This can help you get the best possible deal in the event that you decide to raise funds or sell your business.