The Importance of Business Valuation

Raghunath.T, Director

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Business is as unpredictable as life. Today you might be a successful businessperson, having built an impressive empire, but tomorrow you might be placed in a challenging position, with mounting bills to pay or investments to make.

Many people give business valuation a thought only when a crisis occurs and they are forced to sell the company. Knowing the actual worth of your company beforehand will help you handle crises in a much better way. Valuation helps in determining the economic value of a business, asset or company.

Why should I value my business?
Business valuation is conducted for a variety of reasons and selling the company is just one among them.

Capitalizing on Opportunities
Business owners might be in positions where they spot sudden new opportunities that need investment but are unable to raise funds on their own quickly enough to capitalize on them. At this time, a valuation will be useful in raising capital – whether through investors or lenders.

For Mergers, Acquisition and Sales
When you know the actual worth of your company, it becomes easier to negotiate and the result is a much better price for your company. One must be able to convince the company planning to acquire or merge with your firm, about the value of your business, what the asset holdings are, how the company has evolved over the years and how it will continue to do so.

As a seller, if you feel that the other company is offering a price way below what you deserve, you can easily cancel the deal and look for another, because you know how valuable your company is.

Valuation for financing
Banks will validate their investment in your business prior to providing capital and hence business appraisal of your assets is a must.

Valuation for estate and gifting
It is always advisable to conduct valuation if the business is part of your estate and this is often done prior to estate planning, gifting of interests, or following the demise of the owner.

Ways to determine the value of your company

Income Approach

An income-based approach helps in determining the amount of money the company will generate in the future. It helps in assessing risk as well.
The capitalization of earnings (or cash flow) methodology and the discounted cash flow methodology are the two primary income-based approaches used to value a business. 

Under the Earnings Capitalization Method, the value of the business is arrived at by capitalizing its future maintainable profits. The future maintainable profits are calculated based on the past or the projected working results of Company, usually for a period of 5-7 years, after adjusting for non-recurring, unusual and extraordinary items of income and expenditures. 

The Discounted Cash Flow (DCF) method helps in estimating the value of business based on its future cash flows. This technique is one of the most rigorous approaches to valuation of a business.  In this method, the projected free cash flows from business operations are discounted at the weighted average cost of capital and the sum of such discounted free cash flows is the value of the business. 

The DCF analysis involves determining the following:

  • Estimating future free cash flows
  • The time frame of the cash flows
  • Appropriate discount rate to be applied to cash flows
  • The continuing value or terminal value i.e. the cumulative value of the free cash flows beyond the explicit forecast period
  • Value of debt

Market Approach

In Market-Based valuation approach, the value of your business is determined by reviewing actual transactions and comparing the selling price of similar businesses. For reliable data on such transactions, comparable publicly listed company information on precedent transactions are used to arrive at comparable enterprise values .

Asset- based approach
In this form of valuation, the value of a company’s assets or the fair market value of its total assets after deducting liabilities is taken into consideration. This method has inherent technical complexities and often involves accredited industry expert valuers, hence it requires a certain degree of specialized sector knowledge.

Business valuation is fundamental in not just knowing the value of your business; it also helps in strategic growth planning, in accomplishing your professional goals and at times, even in planning your retirement!

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