Business Valuations
How are Businesses Valued? Our Virtual Finance Directors are regularly asked to help Value Businesses. Typical business valuation techniques include:
Profit Multiples
Often used method when a business is making good profits. However be careful to watch which level of Profit is used eg. 5 times EBITDA is often higher than 7 times Post Tax Profit! In addition watch whether the multiple is on historic profit (as favoured by Acquisitive companies) or on future profit (as a business would prefer to be sold on).
More details on Profit Multiples
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Net Asset Value
Net Asset Value is typically used when a business is either breaking even or perhaps marginally loss making. Use of this method without any Profit multiple implies that the business can not be valued for its ability to generate profit (the business making a Profit is too uncertain). The Net Asset Value is essentially the realistic Balance Sheet value at a point in time; care needs to be taken over the valuation of each main asset type to ensure the correct Net Asset Value is derived. This method is also sometimes used in conjunction with the Profit Multiple discussed above, particularly where the business has a Balance Sheet which is stronger than you might expect for the type and size of business.
Pay Back Method
This method is simplistic, however it can provide a useful way for a Finance Director to explain the business valuation to non-financial Board member colleagues. The Pay Back method is calculated by forecasting the future Profits of the target business and determining how many months or years of such profits are required to pay back the original investment. Please note that the original investment value should also include the costs of acquiring the business. The actual payback period so calculated is subjective as it does depend on the forward forecast for the target business, in turn driven by the expected Cost and Sales synergies from the new group.
Discounted Cash Flow
This method may be applied by specialist buyers. Essentially the potential acquirer will forecast the future cash generation of the business and then apply a discount factor to future years cash generated to give a Net Present Value for that future cash flow. This is on the premise that 1m in a years time is worth less than 1m today.
Other Methods
In specific situations other methods may well be used. For example if a target business is close to insolvency a liquidation basis may be applied. This typically involves reviewing each asset category and assessing how much the asset could realise in a 'fire sale' situation.
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