The Market Value of a company is the total worth of the business and its assets to the financial market participants. For public limited companies, commonly market value refers to the total market capitalization of that company. Determining the value of a company is both an art and a science and therefore requires considerable expertise in that particular field.
There are three basic approaches to the Valuation of a company.
BASE IT ON REVENUE
Revenue is the crudest approximation of a business’s worth. Often, businesses are valued at a multiple of their revenue. The multiple depends on the industry. This is a market-based approach to valuation that considers the revenue multiples of publicly traded companies that are similar to the ones being valued. The companies chosen as comparable should be the ones operating in a similar or identical industry and sector, with the same size and characteristics.
To arrive at the business valuation, the relevant earning base (company profit) is multiplied by the earnings multiple. The earnings multiple reflects the risk attached to future earnings. The lower the deemed risk, the higher the earnings multiple and vice-versa. This is also a market-based approach to valuation which is similar to the previous one to ascertain the market value of the company. Here, instead of revenue multiples, the various earning multiples are taken into consideration.
DISCOUNTED CASH–FLOW ANALYSIS
Discounted Cash flow (DCF) is a valuation method used to estimate the value of an investment based on its future cash flows. Future cash flow is arrived at from the financial forecast of your business and its historical financials. It is an income-based approach to valuation which is based on the assumption that the value of a business is equal to the present value of its cash flows (The cash flows here also include the terminal value of the company being valued). This valuation method can be used to derive both the equity value and the enterprise value.
To calculate the Firm/Enterprise Value, one has to use the firm’s Free Cash Flow. On the other hand, to estimate the equity value, one has to use the Free Cash Flow to equity. We can also arrive at the enterprise value by adding the equity value and net debts.
VALUE OF ASSETS
The Assets Based Approach to valuation considers the fair value of a company’s assets after deducting the liabilities after which the fair value of the company is derived from evaluating its assets. This asset approach to valuation is usually used by companies going into liquidation or companies in the financial or investment industry. This approach, however, does not take into consideration future potential earnings and profits. Therefore, the real value might not be ascertained. It is a very complex method and requires profound knowledge, experience, and accuracy. There are three methods to arrive at the valuation of a company using the value of assets. They are-
Replacement Cost Method
Reproduction Cost Method
BEYOND FINANCIAL FORMULAS
The market value of a business doesn’t confine itself to the formulas and the above methods. Therefore, don’t just base your assessment of the business’s value on number crunching. Value it based on your strategic position in the market and any expected synergies with the acquirer. Whenever you ascertain the market value of a business, both the art and science of valuation must be taken into consideration to arrive at the proper value.