Business Valuations: What Are They and Why Are They Important?

A business valuation is a formal statement of the full value of a business.

It can take into account aspects such as:

  • The company’s potential for revenue generation now and in the future.
  • The company’s tangible assets, including property, equipment, and so on.
  • The company’s intellectual property and other potential for development.
  • The company’s liabilities, the wider market picture, and other risk factors.

Performing a business valuation is a multi-step process. It includes a complete review of all the company’s financial information and the history of its operations. All assets controlled by the firm must also be taken into account, from office supplies all the way up to securities.

Why Do You Need Business Valuations?

There are several reasons to perform business valuations:

Mergers and Acquisitions

Before a company can be sold or merge with another, a comprehensive valuation must be on record. The valuation helps current, and future investors plan their approach to the transaction.

When private firms are on the market, the valuation is an essential piece for assuring current owners that a given deal will meet the target multiple within their exit strategy.

Investor Funding

No matter whether a company is in need of seed or growth capital, investors of all stripes want to understand the true valuation of an enterprise before they will commit to an equity stake.

IPO

In the U.S. and most other jurisdictions worldwide, regulatory compliance demands a full valuation be performed in consultation with a reputable accounting firm before an enterprise can issue securities on a public stock exchange.

Internal Accounting

Rarely, a company may perform a valuation to develop an accounting baseline and better track how future projects and programs, like a new product launch, affect financial performance.

How Are Business Valuations Performed?

There are several different methods for business valuations, and no single method is perfect. The selection of the right method depends upon the size, structure, and assets of the company as well as external factors, such as the generally accepted practices in a given region.

Business valuations can be executed in any of the following ways:

Market Capitalization

This is the simplest method and is determined by multiplying a company’s current share price by the current number of shares outstanding. This is the most common approach for publicly-traded entities of all sizes.

Earnings Multiplier

For greater accuracy, this method focuses on total profit instead of sales revenue. Future profits are adjusted against cash flow that could be instead be invested, using current interest rates to forecast the likely value of the prospective investment.

Discounted Cash Flow

Like the earnings multiplier method, DCF uses cash flow as one of its principal factors. Future cash flow projections are adjusted to estimate a company’s current market value. It differs from earnings multiplier in that inflation is factored into the calculation.

Book Value

Book value is derived by subtracting the enterprise’s liabilities from its assets.

Liquidation Value

Liquidation value is the net cash attainable if an enterprise immediately liquidated its assets and paid off its liabilities from the proceeds.

Many other frameworks for business valuation exist. It is important to recognize that business valuations are long-term projects which may take months to complete. To maximize accuracy, a valuation should begin as soon as possible once deemed necessary.

Business valuations are complex, requiring expertise and attention to detail. To protect the company’s reputation and earnings potential, every valuation must be transparent and error-free. Working with a trusted CPA is crucial.

To find out more or get started, contact R&A CPAs today.

About the author

Amy began her career at R&A in August of 2006 and is experienced in partnership taxation, high net-worth individuals and business consulting