The Methods of Business Valuation
As mentioned, you can use different methods to assess the economic value of a business. While several formal models will provide accurate assessments, it’s important to remember that estimating the fair value of a business is both an art and a science. Choosing the right valuation method and appropriate inputs is a subjective process.
Here are a few of the more commonly used business valuation methods:
Market Capitalization Method
Probably the most straightforward method of business valuation, the market capitalization method calculates a company’s economic value based on the current price of its outstanding shares of stock. As an example, if a company has a current stock price of $50 per share and a total of one million shares outstanding, then the company would have a current economic value of $50 million, according to the market capitalization method.
1 million shares * $50 / share = $50 million valuation
Times-Revenue Method
The times-revenue method examines a company’s economic value through its revenue streams. Also known as the “multiples of revenue method,” this method applies an arbitrary multiplier to the company’s revenue streams over a period of time (e.g., the previous fiscal year) to produce a range of values for the business. To determine the correct value of the multiplier, one must analyze a variety of factors including the macroeconomic environment, industry conditions, etc. Companies poised for high growth and expansion will earn higher multipliers, while slow-growing firms will likely have a multiplier below 1.
Liquidation Value Method
A company’s liquidation value is the net cash it would have if it sold off its assets and paid off its liabilities. If a company can generate $100 million from its assets, and has $95 million in liabilities, then the company has a value of $5 million, using the liquidation value method.
$100 million in assets – $95 million in liability = $5 million valuation
This is by no means an exhaustive list of the business valuation methods in use today. Other methods include replacement value, discounted cash flow, breakup value, and many more. Though they employ different approaches, these methods all attempt to tie the economic value of a company to hard, objective indicators.