How to evaluate the company?

Service Business

Business valuation is needed by entrepreneurs in situations where the plans include taking over or merger, but also when making decisions within the company that are to affect its future. Importantly, the valuation of a company is not only a calculation of how much individual equipment is worth, but also how valuable is the potential of a given company.

The company can be valued using one of the three methods - property, market or profit.

Property methods

Property methods are the classic, oldest solution. The basis of the company's value are its assets and liabilities - therefore it is easiest to use the company's balance sheet. However, it is worth remembering that - as already mentioned - the balance sheet itself does not fully reflect the value of the enterprise, as it does not include additional elements, such as know-how.

Among the property methods, the net book value method is the most basic. It is it that is based on the balance sheet, i.e. the reduction of the company's assets by long and short-term liabilities. However, this method of valuation can be additionally extended by the revaluation of individual assets and liabilities in accordance with their market value. It is then called the Adjusted Net Asset Value.

Another property valuation method is the replacement method. It consists in estimating the financial outlays that would be necessary to restore individual elements of the company's assets. Its advantage over the methods is the fact that in practice it reflects the real value of the company, taking into account also inflation or the consumption of individual components. However, a certain imperfection here is the difficulty of estimating how much the company's reputation or its market potential is worth. Recreation is most often used in the case of entrepreneurs who are considering the option of buying the entire company, or building a new business from scratch.

The last property method is called liquidation. Here, the value of assets is also estimated, but in this case - in terms of revenues that could be obtained from their sale. All financial liabilities that would have been incurred in the event of the liquidation of the company should then be subtracted from the sum received. Thanks to this method, it is possible to estimate the lower value of the enterprise.

Market methods

Market methods are also called comparative - their basic mechanism is to compare market or transactional multipliers with competition multipliers. In practice, this simply means comparing the situation of your own company with the competition operating on the market. The advantage of this group of methods is their simplicity and speed of execution.

In order to make a good market valuation, you should first of all focus on the right choice of companies for comparison. The best solution is to choose enterprises from the same industry, and - if possible - with similar costs, assets, and income. It would also be good if the company selected for comparison had similar growth potential and risk.

Most often, the valuation of enterprises uses multipliers to compare:

  • share price (market value) to net profit - P / E,
  • enterprise value up to book value - P / BV,
  • goodwill to sales revenues - P / S.

To use comparative methods, the trader should start by selecting one of the indicators. Then select the companies to which the company will be compared. For each of them, the selected indicator is used, and then the results are summed up and the arithmetic mean is taken from them. Only after these operations, using the indicator, you can make calculations in relation to your own company, and after making any corrections - make a valuation.

Income methods

The group of income methods is considered to be the best and the best reflecting reality. It consists in forecasting cash flows that will be generated by the company in the future.

The most popular income method is the discounted cash flow method - DCF. There are several variations of this model, distinguished by the level of detail and design.

As you can see, when deciding on the valuation of his business, the owner has a number of methods at his disposal. However, it is worth remembering that each of them is burdened with a certain error, therefore the best solution would be to use at least two methods at the same time, thanks to which the created valuation could better reflect the actual condition of the company.