The Importance of Business Valuation
There are many reasons why Business Valuations are important. It is an essential input to many of the decisions that boards, management, regulators and investors make every day in modern business Such As:
- Exit strategy planning
- Buying a business
- Selling a business
- Strategic planning
- Selling a share in a business
Why is called business valuation ?
Determining the true value of a business, a process called “business valuation,” is not just important when the owner is looking to sell the company.
To obtain a business valuation, business owners may wish to contract with a professional appraiser to provide an opinion that will be viewed as independent and objective with the IRS. The resulting business valuation then may be used in a variety of planning applications.
Not all the methods adopted internationally can be fit locally; this fact is rarely considered, especially that the problem of estimating the fair value of assets and companies has become one of the most debatable issues in most of Arab countries.
How does the business valuation process work?
Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. An accurate valuation of a closely held business is an essential tool for a business owner to assess both opportunities and opportunity costs as they plan for future growth and eventual transition. It provides either a point-in-time assessment of relative value for an owner, or perhaps the price a buyer would be willing to acquire the business.
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Common Business Valuation Methods:
Company’s assets include tangible and intangible items. Use the book or market value of those assets to determine your business’s worth. Count all the cash, equipment, inventory, real estate, stocks, options, patents, trademarks, and customer relationships as you calculate the asset valuation for your business.
In this valuation method we estimate the value of an investment based on its future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future. The Discounted Cash Flows Method requires the following analysis – Revenue, Expense, Investment, Capital structure and Residual value analysis. It values the company considering:
- Free cash flow to the firm (FCFF).
- Free cash flow to equity (FCFE).
Book value is total assets minus total liabilities and is commonly known as net worth. The book valuation technique is usually used as a method of cross-testing the more common technique of applying multiples to EBITDA, cash flow, or net earnings.
The cost approach is based on the logic of the principle of substitution. The concept is that prudent investors will not pay more for a property than they would for a substitute property of equivalent utility. As with the market approach, there are two potential starting points for a cost approach to valuation: reproduction cost and replacement cost.
Reproduction cost is the estimated cost, at current prices, to create an exact replica of the subject asset, using the same materials, construction techniques and standards, design, and quality of workmanship, and incorporating all the property’s deficiencies, over-adequacies, and obsolescence’s into this exact duplicate.
Replacement cost is the cost to replace an existing property with a new one of equivalent utility, as of a specified date.
Finally.. the concept of estimation and determination of fair value is extremely relative and complicated. Accordingly, it is very difficult to arrive at a conclusion whereby an accusation of detriment is hurled or a reform is praised. In witness whereof, in order to seek a fair judgment and objective thinking, we have first to ask about the basis and assumptions of evaluation if we really want to safeguard our sold assets.