What is Valuation?
Valuation refers to the process of assessing and determining the current worth or the present value of a company or an asset. It is usually done by analyzing and examining the management, potential profits, market value of the company’s assets, its capital structure, etc. A valuation can also be performed on the assets or liabilities of a company and helps in improving its business.
According to the Professor. Aswath Damodaran at the NYU Stern Business School, who is known for his various theories and insights behind valuations, a good valuation should encompass both the numbers and the story.
The steps of valuation, according to Prof. Aswath Damodaran, are as follows:
The first step involves developing a narrative for the business which is being valued. The narrative should tell the story behind the company and its future growth.
The second step involves checking if the narratives are possible, plausible and probable.
The third step involves converting the narratives into value drivers. That is adding numbers for the stories. The numbers could be anything from cash flows to risk.
The fourth step involves connecting these value drivers to arrive at an end value for the business.
The fifth step involves having the feedback loop open. This involves having an open mind and considering the insights given by the people who know the business better. It is essential to have a dynamic model and change the same as and when the narratives change.
Why and when do we perform valuation?
Valuation is done for a variety of reasons and plays a vital role in improving the growth of a company. Some of the reasons and circumstances under which valuation is performed are as follows:
Strategic Planning
The fair value of the asset of a business might not be revealed. If necessary adjustments aren’t made to the balance sheet, it becomes perilous for the company. Thus fair valuation will help the business make better-educated decisions and help in strategic planning.
Buying and Selling of Business
Whenever one plans to buy or sell a business, it is imperative to know the current worth to ensure that it is priced correctly. Both the buyers as well as the sellers have different views and opinions regarding the same business. The buyer must ensure that the company is valued correctly and according to the market conditions instead of being overvalued. On the other hand, the sellers need to be paid what the business is worth. Valuation helps ascertain the fair price.
Funding
To get funding for one’s business, it is essential to create a valuation report with the business’s current value. This makes it easier for the company to negotiate with the banks and other financial institutions to raise funds.
Litigation
In case of any litigation or claim such as injury, it is essential to value the company at its current worth. This is because damages are paid based on the actual worth of the business.
Exit Strategy Planning
If there is a plan to sell the business, it is imperative to plan for a successful exit. At that time, the company’s valuation would help develop a comprehensive plan and strategy to increase the profitability as a way to increase the value of the company at exit.
Selling a Part of the Business
For owners willing to sell their shares, it is imperative to know the current worth of the business to earn a fair value.
To get funding for one’s business, it is essential to create a valuation report with the business’s current value. This makes it easier for the company to negotiate with the banks and other financial institutions to raise funds.