How do you value a company?
Company Valuation Methods
There are many ways to find out about company valuation, but it really depends on what is the company’s nature and in what stage is the company. For example, valuing a company going for liquidation is different from valuing an operating business. What about to value a company that is lost making vs another that is profit making?
Here are the different methods to value a business.
What are the Main Valuation Methods?
There are three main valuation methods used by industry practitioners when valuing a company as a going concern: (1) Market Approach , (2) DCF analysis, and (3) Cost Approach. These are the different methods of valuation used in investment banking, equity research, private equity, corporate development, mergers & acquisitions (M&A), leveraged buyouts (LBO) and other areas of finance.
As shown in the diagram above, when valuing a business or asset, there are three broad categories that each contain their own methods. The Cost Approach looks at what it cost to build something, and this method is not frequently used by finance professionals to value a company as a going concern. Next is the Market Approach, this is a form of relative valuation and frequently used in industry. It includes Comparable Analysis Precedent Transactions. Finally, the discounted cash flow (DCF) approach is a form of intrinsic valuation and is the most detailed and thorough approach to valuation modelling.
Method 1: Market Analysis Approach
Method 2: DCF Analysis Approach
Football Field Chart (summary)
As you can see, the graph summarizes the company’s 52-week trading range (it’s stock price, assuming it’s public), the range of prices analysts have for the stock, the range of values from comparable valuation modeling, the range from precedent transaction analysis, and finally the DCF valuation method. The orange dotted line in the middle represents the average valuation from all the methods.
Method 3: Cost Approach
The cost approach, which is not as commonly used in corporate finance, looks at what it cost or would cost to re-build the business. This approach ignores any value creation or cash flow generation and only look at things through the lens of “cost = value”.
This approach is more commonly used for company who has not make any profit or revenue. Many start-ups who has built technology platform can often use the cost to acquire the number of customers as part of the valuation of the business. It literally covers the opportunity cost that the entrepreneur lost when he do this business, including the possible salary he lost during this period of time and the effort he spend and his company’s IP rights, customer acquisition and other databased they have built and acquired during this period of time.
If the investor set up a new company on his own, how much does he need to spend to create a company with the exact value as yours. This is the value, which is also the Replacement Cost.
If the company will not continue to operate, then a liquidation value will be estimated based on breaking up and selling the company’s assets. This value is usually very discounted as it assumes the assets will be sold as quickly as possible to any buyer.
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