Valuation is a process used to establish a company’s worth in dollars. A variety of methods are used including: Equity-based, asset-based and market-based approaches. Rules of thumb are also used as quick checks.
Analysts often begin a valuation with equity-based methods to evaluate the company’s current and historical results. They project different scenarios for the company’s performance (best case, worst case and most likely). They then use market-based methods to estimate what a buyer might pay for the company, assuming the process is voluntary on both sides.
Asset-based methods are used to determine how much the company might be worth in a liquidation scenario. Rules of thumb such as the price earnings ratio are used to quickly check that the results are reasonable.
When completed, the information from each approach is combined to establish a range of values for the business.
The valuation process is important, because it is used to set limits on how much financiers might lend or invest in a business.
More about valuation
The most common equity-based valuation method is discounted cash flow (DCF), which establishes the value of a company using several different operating forecasts.
In the asset-based approach, information is taken from a business’s balance sheet to estimate the fair-market value of the company’s assets. Total debts are subtracted and the result is the net asset value (NAV).
The market-based approach uses the market to determine the market value. This can include methods such as:
- Looking at the sales prices of comparative firms that have been recently sold to determine the multiple of earnings that was paid
- Comparing the earnings and stock prices of companies in the same industry
- Segregating the real estate assets and doing a market comparison just on that portion