What is Business Valuation and what are the different factors and method that we can use for business valuation? There are mainly six ways to evaluate the business and know it’s economic value – Market Capitalization, Times Revenue Method, Earnings Multiplier, Discounted Cash Flow (DCF) Method, Book value and Liquidation value.
Let us understand Business Valuation factors in detail.
- What is Business Valuation in India?
- 6 Methods to Evaluate Economic Value of Business
- 1. Market Capitalization
- 2. Times Revenue Method
- 3. Earnings Multiplier
- 4. Discounted Cash Flow (DCF) Method
- 5. Book value
- 6. Liquidation value
- Frequently Asked Questions
What is Business Valuation in India?
- Business Valuation in India is a method to know the economic value of a company, and how the company grew over a period of time
- Economic value of a company is mainly required when someone wants to buy stocks or shares of the company so that the total value of the company can be determined to know the intrinsic value of the stock that he / she wants to buy
- Apart from buying stock of the company, business value can also be required during partnerships with other firms, selling of a company or even in divorce proceedings
- It is very important to evaluate the business value of a company so that the stake holders are aware about the economic value of company at any given point of time. Some of the financial statements required to be analyzed are Income Statement, balance Sheet and Cash flow statement.
- The best way to find economic value is to subtract the total liabilities that the company has from the total assets
- Assets are things that help the company make revenue and profits such as land, machines, inventory, etc.
- Liabilities are things that makes the company to pay for the rent, buy goods or raw materials and other things for which company pay to generate cash
Let us now understand 6 methods to evaluate business and find economic value of a business.
6 Methods to Evaluate Economic Value of Business
Below are 6 methods to evaluate economic value of a business:
1. Market Capitalization
Market Capitalization or market cap is one of the important ways to evaluate the economic value of a business. Below is the formula for calculating market cap of a company:
Market Capitalization = Total Number of Shares * Stock Price
In above formula of market cap, the stock price keeps on changing every day, but the total number of shares does not change frequently. So based on this formula, the market cap fluctuate on daily basis based on the price of the stock.
For example, as of January 2024, Reliance Industries had total number of shares as 6,765,460,910 and the stock price was Rs. 2,596.65, thus having a market cap of Rs. 17,56,753 crore
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2. Times Revenue Method
Another method to evaluate companies is the times revenue method in which case the revenue of the company is multiplied with some factor to reach the value of a company. Revenue can be considered for couple of more quarters to take the average of revenue generated by company and than multiplied by a factor.
The factor can be 2x to 3x for a product based company and can be 0.5x to 1x for service company.
3. Earnings Multiplier
Earnings multiplier is the better approach compared to revenue multiplier, since we deal with earnings or profits of the companies in this case which should be the correct unit after removing the cost of the products. Profits of companies are more reliable indicator for success of a company compared to sales revenue generated.
4. Discounted Cash Flow (DCF) Method
DCF or discounted cash flow model is one the the popular methods to evaluate businesses which is similar to earnings multiplier. In this method, we project the future cash flows of the company and determine the current market value after such projections.
The main difference between DCF and earnings multiplies is – in DCF inflation is also considered for calculating business value
5. Book value
Book Value of a company is a straight forward method to find the economic value of a company. Below is the formula to find book value of company:
Book value = Total Assets - Total Liabilities
Based on above formula, book value tells us the amount that remains after subtracting total liabilities from total assets. This book value must be positive number, else if liabilities is more than assets of a company than it is a problem.
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6. Liquidation value
Liquidation value is similar to book value, but in terms of cash. It specifies the amount a company can get after liquidating or selling all current assets and paying all the existing liabilities. The balance amount will be received as cash by the company from the buyer and this is also one of the important factor you should consider to know whether a company can get a positive cash flow.
So these are the 6 important methods to evaluate business out of which subtracting the liabilities from assets is an important factor to know the economic value of a business. Please note that this is not the exhaustive list of evaluating businesses and there are many other factors that can be considered.
Business valuation is a process to know the economic value of the business, that is required by share holders, firms who want to have partnerships and for other reasons as well.
Frequently Asked Questions
How do you calculate a business valuation?
Simple method to evaluate businesses is to subtract total liabilities from total assets to know the book value of a company. This is the value that company can get if it was to get liquidated or sold today.
What is the formula for the value of a business?
The formula for book value is total assets – total liabilities which is one of the important ways to evaluate businesses. Apart from this formula, you can also consider debt ratio to estimate the business worth
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