Tue. Aug 2nd, 2022
    Business valuation

    Business Valuation

    The business valuation is comparable to the value of the economic assets or present value of this company. It is estimated from the value of its equity added to its net financial debt.

    In financial markets, this enterprise value is often considered more representative than market capitalization, which is limited to the number of outstanding securities multiplied by the share price.

    The interest of the enterprise value is that it makes it possible to compare the performance of groups that do not have the same financial structure.

    How to calculate business valuation?

    Setting an enterprise value means estimating a company at “fair value” (its market price).

    This valuation is useful for internal purposes, when it comes to allocating goodwill (difference between the acquisition price of a company’s securities and its net accounting position);

    It is also useful for external purposes, such as when a company must provide justification to the tax authorities or even carry out a minority sale between shareholders.

    The value of the company, calculated at a time T, is conditioned by 3 elements:

    • the economic situation (GDP growth, stock market climate, economic confidence index);
    • access to financing (attitude of lending banks, etc.);
    • regulatory changes (administrative and tax constraints, etc.).
    Generally, the value of the company is assessed using the following formula:

    Value of equity + value of net financial debt = value of the company.

    Good to know: the enterprise value is a transparent indicator, because it includes the debt owed to creditors.

    If the company is not in debt, but has excess cash, then its value is equal to the difference between the value of equity – cash.

    For its part, the capitalization (value of the shares) is equal to the enterprise value from which the debts are subtracted. If the company has no net debt, but a surplus of cash, its capitalization is equivalent to the enterprise value + cash.

    3 methods of assessing business valuation

    Several methods are used to calculate the valuation of a company: the heritage approach, the comparative method and the yield method.

    1. Legacy method

    It assesses the value of a company by adding up what it owns on the valuation day. Once this asset has been valued, the debts contracted are deducted. The result obtained constitutes the net assets, i.e. the enterprise value. The calculation formula is as follows:

    + capital gains/losses on intangible assets;
    + capital gains/losses on other economic assets;
    + capital gains/losses on financial fixed assets and holdings;
    + capital gains/losses on other balance sheet items = net assets.

    Note: although this approach is rigorous from an accounting point of view, it has the disadvantage of not taking into account various factors, including the growth potential of a company.

    2. Comparative method

    This method consists of identifying the prices charged and drawing inspiration from them to set a selling price.

    The evaluation is carried out based on a scale or a ratio often observed in the same sector of activity. This valuation is cross-referenced with that of the company, itself derived from the last 3 balance sheets (+VAT). A general average is taken from this.

    Mainly used when selling businesses, this method has the particular drawback of not taking the lease into account, as the value ranges obtained can also be very wide.

    3. Yield method

    It is based on the real potential of the company and its ability to generate profits.

    The valuation relates to the recurring result observed over several past financial years. This result is then valued by discounting at a rate X.

    This evaluation method can be summarized as follows:

    Business earnings ÷ discount rate = business value.

    In a number of cases (start-up, strategic merger between two companies), the DCF (discounted cash flow) method is used. Enterprise value derives from the estimated cash flow that shareholders will receive in the future.

    Reminder: cash flow corresponds to the cash flow available to a company.

    Sources: PinterPandai, Investopedia, Corporate Finance InstituteCO — by U.S. Chamber of Commerce

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