Business Valuation For Investor Assessment
Objective of this service
“This service guides you on the ABCs of how to get a business valuation done for investor entry & exit. Critical factors to consider here are the liquidation preferences and dividends, which will help the evaluator determine if this is a good business proposition.
What are the ways of valuing a company? There are several ways to determine the market value of the business, i.e., adding up the value of business assets (including all equipment and inventory), the quantum of revenues and earnings it can expect, usage of earnings multiples like the P/E price-to-earnings ratio, conducting a discounted cash-flow analysis, and going beyond financial formulas to consider the business value based on geographical location, and the strategic value for a potential investor, assuming business synergies.”
What is Business Valuation? & How to determine a business valuation?
“Business valuation is a technique used to assess or find out the accurate financial or economic value of a business or entity. Business valuation can be used to assess the fair worth of the investment for various considerations like determining the business sales value and establishing partner ownership and taxation. Investors or owners generally turn to professional business valuation services for an objective estimate of the value of the specified business.
How to calculate business valuation? The primary business valuation methods can be explained as follows:
- Market Capitalization: The simplest and most fundamental method of business valuation, this is calculated by multiplying the company’s share price by its total number of shares outstanding.
- Times Revenue Method: In this business valuation calculator, the revenue streams generated over a certain period are applied to a multiplier, which is based on the industry and economic environment. For example, a tech company may be valued at a certain revenue, while a service firm may be valued differently.
- Earnings Multiplier: A company’s profit or earnings (vis-à-vis sales revenue) is perceived to be the right indicator of business value and financial success. The earnings multiplier method adjusts anticipated future profits against cash flow that could be invested at the current interest rate over the same period. Thus, it adjusts the current P/E ratio to account for current interest rates.
- Discounted Cash Flow (DCF) Method: This key business valuation calculator is similar to the earnings multiplier. The technique is based on future cash flow projections, which are adjusted to get the current company market value. The DCF method is different from the profit multiplier method since it considers inflation for calculating the present value.
- Book Value: This is the value of shareholders’ business equity as shown on the balance sheet, and is derived by subtracting the total company liabilities from its total assets.
- Liquidation Value: This is the net cash that a business will receive if its assets are liquidated and liabilities paid off, as of today.”
Challenges while doing assessment of Business Valuation
“Business Valuations are generally based upon three principal approaches: i.e., the income, market, and cost (or asset) approach. Here are the fundamental challenges encountered while undertaking business valuation services:
- Developing reasonable assumptions for projections based on historical trends and expected future occurrences and documenting the reasoning behind those assumptions made.
- Requesting, tracking, and reviewing the necessary documents, including the tax returns and financial statements.
- Finding robust private-company industry data to benchmark the subject entity.
- Gathering the appropriate market parameters (both public and private) and documenting the reasoning behind these choices.
- Estimating a discount rate that can accurately mirror the inherent risk in a business entity, and documenting the reasons for employing the methods used for calculating the WACC (Weighted Average Cost of Capital).
- Building a comprehensive valuation report, and remaining compliant with all relevant guidelines, and applicable industry standards.
Business valuation methods have now evolved amidst the backdrop of the COVID-19 pandemic. The specific issues and challenges faced under this new normal are:
- One size does not fit all: Not all businesses have been negatively impacted by Covid-19. In the valuation analysis, we should look at specific issues affecting the business finances and operating outlook.
- Emphasis on the DCF approach: The DCF method has become the preferred business valuation method in current times. The business evaluator has to use his judgment, along with the management perspectives associated with the company’s long-term prospects.
- Higher discount rates adversely impact business values: The heightened business risks and uncertainty in this post-pandemic era affects the company or investment’s risk profile and its business valuation.
- The weighted average cost of capital (WACC) is trending higher: The WACC represents the discount rate used to convert prospective cash flow, at the invested capital level, to its equivalent net present value. Many of the underlying market-derived WACC inputs have risen of late, in line with the prevailing business conditions in the COVID-19 era.
- Risk and uncertainty must align with the company’s outlook and operating projections: If the company’s cash flow has considered long-term Covid-19-related impact, then the selection of a discount rate must be commensurate to that forecast risk.
- Focus on forward-looking public company market multiples: Recent financial history of a company (its past revenue, earnings, cash flow, etc.) are now viewed as less reliable parameters since they might not fully reflect its post-Covid-19 financial conditions and earning power outlook.
- Market transactions of non-publicly-traded companies occurring in the past are given little weightage in current valuation processes. Business valuations under the guideline transaction company method (GTCM) are generally viewed as less reliable because of dated, less detailed market multipliers.
- The cost (or asset) approach is more significant: Today, the cost approach is frequently used, especially when a company may be worth more in net asset value terms.
- Higher discounts for lack of marketability: In the present Covid-19 environment, business transactions and market activity have decreased significantly, leading to decreased liquidity.
- Rigorous asset impairment testing and recognition procedures will be the new reality: Businesses have nowadays experienced significant structural changes in their operating models, which, in turn, may give rise to a significant magnitude of asset impairment charges arising out of financial uncertainty.
- For many businesses, restructuring, and reorganization is the new reality: Under Covid-19, and the concurrent economic environment, businesses may fail and/or be forced to restructure and reorganize. In these instances, businesses and their underlying assets may require independent, fair valuations.”
Why DFX for Business Valuation?
Digital Finance Experts (DFX) is a leading financial and business consultant offering a wide range of industry-ready services & solutions across the globe, including customized business valuation services for potential investors. The company has years of proven expertise in all dimensions of financial feasibility and business valuation and is spearheaded by experienced industry-renowned financial and business strategists. DFX and its sister organizations have been strategic and transformational partners for several top-tier clients over several years, expertly guiding potential investors on how to calculate business valuation. As your trusted business valuation specialist, DFX can help you to successfully assess the true financial worth and potential of your business, providing you with the perfect launch pad to kick-start or optimize operations. If you are an aspiring investor looking out for the best business valuation possible, please connect with DFX experts right now to unlock the true potential of your enterprise, and firmly embark on your journey to success!
Business valuation for investment assessment involves detailed online web-based research, to make a quantitative and qualitative assessment of the state and size of the market, industry, and economy, to help identify the unique strategic positioning and competitive advantage of the business. The market size has to be analysed both in terms of volume and value, along with the target customer segments, buying patterns, growth, profitability, cost structure, distributional channels and trends, in the context of the list of competitors. Other key aspects which can be researched on the internet include consumer demographics and profiling (which consists of data on the unique identities and characteristics of individual customers and buyers, i.e., basic information like gender, age, marital status, education, and geographical location) and the economic environment regarding barriers to entry and regulation.
Competitive Advantage Quadrant axis maps are generally competitive positioning maps, providing insights into the target market's competitive landscape, along with valuable inputs into USPs that can make the business product or service unique from that of the competitors. Businesses use these tools to benchmark themselves against competitors, dissect competitors’ strategies, look for growth opportunities and forecast the market’s future. Various types of quadrant axis maps can be used for competitive benchmarking, i.e. a SWOT (Strength, Weaknesses, Opportunities, and Threats) analysis for competitors, the PEST (i.e. Political, economic, social, and technological factor) analysis for competitive research, Porter’s Five Forces Analysis (Suppliers, Buyers, Entry/Exit Barriers, Substitutes, and Rivalry) to determine an industry’s profitability and attractiveness, analysing competitor’s market positioning through a value proposition canvas (which helps develop products that match customer needs and consists of the customer profile and business value proposition), a perceptual map, a radar chart (where competitor products are compared based on different attributes), and a competitor price analysis.
Apart from the competitors, the other players in the target marketplace are:
- Customers: both major and minor customers, and current and potential buyers are included here.
- Suppliers: would include both major and minor ones, who may sell directly to the market or competition. They have to be kept aligned with the company's market strategy.
- Complementors: are those who sell non-competing products and which generally boost business sales.
- Substitutors: are like competitors but their products are not the same. A critical attribute of a substitutor group is that they all seek the same share of the market pie.
- Regulators: consist of organizations promoting effective market competition. In any industry, regulatory standards are often helpful to ensure product safety, helping suppliers create compatible parts that enable economies of scale, conform to the safety and ecological standards, and lower product prices.
- Influencers: are groups who have no direct control but who seek to promote their agendas by influencing players in the marketplace. Lobby groups who represent certain business interests may also be involved, although often indirectly.
Market share in competitive analysis is the percentage of total industry sales generated by a particular company. Market share can be estimated by dividing the company's sales over a specified time by the total industry sales over the same period. This metric is used to give a general idea of the company size in relation to its market and its competitors. The industry market leader is the company with the largest market share. Thus, the specific business or company's market share is its portion of total sales with regard to the market or industry in which it operates. To calculate the company's market share, one has to first determine the period for analysis, which can be a fiscal quarter, year, or multiple years.
Sales Volume Analysis: is a detailed study of a company's sales, in terms of units or revenue, for a specified period. The analysis of sales volume (by sales region or territory, industry, customer type, etc.) is used as a powerful tool in determining the effectiveness of the selling effort.
Margin Growth: To calculate gross margin, one has to subtract the Cost of Goods Sold (COGS) from total revenue and divide that number by total revenue (Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue). The formula to calculate gross margin as a percentage is Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue x 100. With regard to volumes and margin growth, there is generally a trade-off. Positive and ever-increasing operating margins are considered better than lower operating ones. Operating margin is widely considered as one of the key accounting measurements of operational efficiency.
Balance Sheet or BS: is the company's financial statement and includes assets, liabilities, equity capital, total debt, etc. at a given point in time. The balance sheet includes assets and liabilities on each side. For the balance sheet to reflect the true picture, both heads (liabilities & assets) should match (i.e., Assets = Liabilities + Equity).
Profit & Loss statement or P&L: is a financial statement that summarizes the company revenues, costs, and expenses incurred during a specified period, usually a fiscal quarter or year. The P&L statement is synonymous with the income statement. The P&L statement can also be referred to as a statement of profit and loss, income statement, statement of operations, statement of financial results or income earnings statement, or expense statement.
Cash Flow or CF: is a company's financial statement that summarizes the amount of cash and cash equivalent entering and exiting a company. The cash flow statement measures how well a company manages its cash position, implying how well the company generates cash to pay its debt obligations and fund its operating expenses.
Return on Capital Employed or ROCE: This is a financial ratio that can be used in assessing the company's profitability and capital efficiency. Thus, this ratio can help to understand how well a company is generating profits from its capital, as it is employed or put to use. A high and stable ROCE is an indicator of a good company, as it shows that the business is consistently making optimal use of its resources.
Compound Annual Growth Rate or CAGR: is used to calculate the annual growth of the business or investment over a specific period. In other words, CAGR is used to determine the exact percentage of the returns from the investments each year, across the investment tenure.
Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA: is a metric used to evaluate a company's operating performance. It can be seen as a proxy for cash flow. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed by the business in a specified period.
Macro Environmental Factors: The macro-environment is considered to be an external or general environment that is often outside of the retailer’s control and is typical of a larger scale, high-level economic, industry, and overall market scenario. The main macro-environment factors are demographic, economic, natural, socio-cultural, technological, and political-legal. These elements are more complex and are regional, national or global in nature.
Micro Environmental Factors: The micro-environment is essentially an organization or company’s internal, immediate or nearby environment in which it operates. The key micro factors are the customers, suppliers, media, employees, competitors, shareholders, and stakeholders, which could be the government or regulatory bodies. Generally speaking, the micro-environment is less complex and local to the business and every business owner should consider these factors to be affecting the retail business.
SWOT analysis: is a planning tool that helps organizations to build a strategic plan to meet desired goals, improve and streamline operations and keep the company relevant in the market. In a SWOT analysis, organizations identify strengths, weaknesses, opportunities, and threats (the four factors SWOT represents) specific to organizational growth, products and services, business objectives, and overall market competition.
Thus, the key purpose of a SWOT analysis is to identify market-friendly strategies that help create a specific business model that can best align an organization’s resources and capabilities to the environmental requirements in which the business operates. The principles and culture of a SWOT analysis are to build a foundation for evaluating the internal potential and limitations, and the likely opportunities and threats in the external environment. It views all positive and negative factors inside and outside the firm's culture that can have a bearing on its success. A consistent study of the environment in which the firm operates helps in forecasting/predicting the evolving trends, suitably including them in the company's decision-making process.
Discounted cash flow (DCF) approach: is a key business valuation method for investor assessment that is used to estimate the value of an investment based on its expected future cash flows. The DCF analysis tries to estimate the value of an investment as of today, based on future projections of how much money it will generate in the coming period. This applies to investor investment decisions on business entities, such as a company acquisition or an investment in a technology start-up, and also for entrepreneurs and business managers who have to make informed decisions on financial aspects like capital budgeting or operating expenses, with regard to the inauguration of a new factory or purchasing or leasing new equipment. The present value of the expected future cash flows is calculated by using a discount rate to calculate the discounted cash flow (DCF). If the discounted cash flow (DCF) is above the current investment cost, the business opportunity could result in positive returns.
The Net Asset-based approach: identifies the company’s net assets by subtracting liabilities from assets. This business valuation for investor assessment approach focuses on the company’s net asset value (NAV), or the fair market value of its total assets minus its total liabilities, to determine what it would cost to recreate the business. This asset-based valuation approach is less complex and easier to apply, providing an indication of the downside risk, with the value of the underlying tangible assets impacting the overall business valuation. However, it is important to note here that while the assessment of the underlying tangible assets and the liquidity value is a useful tool when deciding on the value of a business, these do not necessarily represent the true value of a going concern.
During a business evaluation, detailed comparison and analysis (including the financials) of the recent listed or private deals, strategic mergers & acquisitions, agreements, co-branding initiatives, tie-ups, and collaborations of the company is essential. Importantly, we have to also assess the efficacy of the evaluated company’s overall strategic planning process, as well as study the company’s overall value creation plan for these deals. The success parameters for all these deals entered into by the company have to be benchmarked with the industry’s measurement norms, taking existing shareholder and stakeholder feedback (on these deals) into consideration. The vision and mission statement, and the skills of the company’s deal advisory and negotiating team also have to be analysed thoroughly to get the correct picture of the entity’s business value ecosystem. Last but not the least, we have to also examine the company’s deal management structure, corporate culture, and the overall talent engagement mechanism for such deals.
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