Whether you're a business owner considering selling up, looking for funds, or are just curious, you'll want to know what happens during a business valuation.
A business valuation involves a thorough assessment of your company to create an unbiased determination of its economic value. In this Tax Natives blog post, we're going to take a deep dive into what happens during a business valuation, including:
- Data gathering and analysis
- Valuation methods
Valuing your business through data gathering and analysis
When it comes to what happens during the business valuation process, the first step is always an in-depth analysis of your company. This includes:
- Financial statements - These documents, ranging from income statements to balance sheets, offer a snapshot of your company's financial health.
- Historical records - This will offer more insight into growth trajectory, profitability, and overall stability.
- Key operating metrics - From gross margins, net profit margins, and return on equity, this gives a deeper understanding of your company's profitability.
Extracting meaningful insight into your business
Once all of this relevant data on your company has been gathered, the appraiser will then review and verify it all to ensure it is all accurate and complete.
They will also gauge the company's position within its respective sector in relation to the business environment, the competitive landscape, and industry trends.
Which valuation method is best for my business?
Once all the relevant data on your company has been gathered, it's then time for the appraiser to choose a business valuation method.
Also known as net worth or shareholders' equity, this is a fundamental method of valuing a business's financial standing.It represents the residual value of a company's tangible assets after all its liabilities have been deducted.
This reflects how much would be left over if the company were to liquidate all of its tangible assets and settle all debts.
In this case, assets include:
- Intellectual property (IP)
- Goodwill (loyal customer base, experienced team, etc.)
- On the other hand, liabilities include:
- Accounts payable
- Accrued expenses
- Outstanding bonds
Book value is a useful starting point for assessing a company's financial health, though it shouldn't solely determine a company's true worth. Some other methods can help create a more complete picture.
Discounted cash flow (DCF) analysis
A DCF analysis is an accurate valuation method that gives the appraiser an estimate of the current value of the company's future cash flow.
It involves the following steps:
- Forecasting future earnings - The cash flow for the upcoming 5-10 years is projected, reflecting the expected operating profit, capital expenditures, and changes in working capital.
- Choosing a discount rate - Determine the appropriate discount rate to apply to these projections, reflecting the cost of capital. This is influenced by the company's risk profile, market interest rates, and risk-free rates.
- Calculating present value - Calculate the intrinsic value, assuming it can maintain its projected cash flows.
Also known as an equity capitalisation, this is a widely used metric to assess the size of a company, as well as its market value.
It broadly indicates a company's overall value and relative standing in the market, and is widely used by investors, analysts, and other stakeholders to understand its investment potential.
However, market capitalisation can be unreliable. This is because it is based on current share price, which can massively fluctuate due to market conditions, company news, and investor sentiment.
This method of business valuation also doesn't consider the potential impact of stock issuances or buybacks, which can dilute or increase the ownership stake of existing shareholders.
This valuation method compares several measures against that of similar companies. These are:
- Earnings Before Interest
This is commonly used to assess the value of a company's equity, as it provides a relative measure of a company's valuation compared to its industry peers.
Generally, a higher EBITDA multiple suggests a higher valuation.
Although this method makes it easy to compare companies across industries, it doesn't consider intangible assets like brand reputation, and IP.
What happens during a business valuation?
Business valuations are a complex and multifaceted process that can involve a variety of different methods to be done properly. They thoroughly assess a company's financial performance, intangible assets, and future growth prospects to understand its overall worth.
And whilst no single company valuation method is universally applicable, they each offer valuable insight, especially when combined.
If you're a business owner looking to understand the complicated world of business tax, get in touch with Tax Natives today
. We'll put you in touch with a professional, regulated tax advisor
who will suit your needs.