How Businesses are Valued
Valuation methods include
|Value of net assets as shown in the books; adjust for depreciation methods? Factor in a goodwill element Take Market Value of net assets; strip out cash and property In many cases owners expect to achieve a premium using this approach
|Ratio(s) of Profits Earning Multiples
|Typically Price/Earnings (P/E) ratios Value of the company; post-tax profits of the company Published figures are per share for public companies Normally based on historic and possibly forward projections for earnings, measured before depreciation, interest and tax, but adjusted for “average Directors” drawings. The range for this earning multiple can vary from less than 4 to greater than 10 and depends on a range of factors and adjustments, some of which are illustrated below.Find an equivalent public company’s P/E Ratio; discount that ratio for the lack of liquidity in private company market; apply to adjusted post-tax profits over different periods: last 12 months, last 3 years, forecasts…..
|Multiples of EBITDA (Earnings before interest, tax, depreciation and amortisation) Earnings before interest tax depreciation and amortization Discounted Cash Flow (DCF) and/or Net Present Value (NPV) calculations Normally based on historic and possibly forward projections for cash flow. Debt funders will focus on historic performance, whereas investors may include forward projections, discounted to reflect timings and risk.
|This is the simplest formula, based on the number of years to recoup investment, usually between 3 and 5 years Adjustment factors include costs of integration and savings from consolidation.
|Return On Investment (ROI)
|ROI based upon forecast post-tax profits Enables easy comparison to alternative investments. Different rates of return used by different buyers Rate of return is set by reference to cost of capital
|Looks at the increased value of the combined businesses Will consider cost of capital, but also earnings dilution (especially important in public companies) Estimating costs of integration but also synergistic benefits
|Often a very simple calculation and widely known in the industry – so almost self-fulfilling. Examples might be n x turnover or n x contracted revenue or £x per subscriber….Very often, this falls in the same range as other methodologies
Prior to estimating any valuation, the reported financial records will probably need to be adjusted. These adjustments are for any expenses that would not be incurred under new ownership, and also to adjust owners / directors salaries to reflect the market rate for the job they actually do.