Top 5 Methods for Company Valuation
1. Market Capitalization
One of the simplest and most popular methods to evaluate business is market capitalization or market cap. It helps investors judge a company’s value regardless of their geographical location.
How It Works: It multiplies your current share price by the number of outstanding shares to calculate their total market value.
When It Is Used: Market capitalization is often used by publicly-traded companies to identify their size, comparing their financial performance to other businesses, regardless of their size.
2. Earnings Multiplier
If you are planning to sell part or whole of your company to a third party, a strategic buyer per se, this method of Earnings Multiplier or Price-to-Earnings Ratio is most imperative.
How It Works: Under this method, the recent earnings of your company are multiplied to calculate its true economic value. The multiplier is variable based on the industry you are in and other factors such as economic environment.
When It Is Used: It is often used when you need to determine the expensiveness of a share of your company’s stock.
3. Discounted Cash Flow (DCF) Method
When you are not sure of profit stability in the future, discounted cash flow or DCF method helps by considering inflation as well as the time value of money to figure out the present value. It makes it easy to evaluate the future cash flow from your business assets.
How It Works: It works by taking into consideration the projected cash flows and discounting them to their present values.
When It Is Used: When you need to make major business decisions or see your projected value.
4. Historical Earnings Valuation
Historical earnings valuation values your business based on your ability to capitalize cash flows and eliminate or repay debts. Looking at the history of your annual earnings, it provides an estimate of your future dividends.
How It Works: The historical earnings valuation method takes into account the above-mentioned factors and the value drops every time the debts exceed your earnings.
When It Is Used: It is often used by companies witnessing rapid growth year over year, with stable earnings.
5. Future Maintainable Earnings Valuation
A simplified version of the discounted cash flow method, the future maintainable earnings valuation method assumes that your future incomes will be similar to those in the past. It helps predict the future cash flow from your business.
How It Works: It determines your business’ current value by assessing its ability to generate profits, expenses it incurs, and the revenue generated in the past three years.
When It Is Used: It is often used when you expect stable earnings in the future.
Now a common pain point here is the complexity of these procedures which, depending on the method you use, results in numbers that vary to a large extent.