How might business leaders value business entities?
finance
Description
Introduction:
How might business leaders value business entities?
For business deals that involve merging, selling, or acquiring companies, the participants should have an estimate of the value of the entity they are selling or buying. This week’s topic explores some methods on how to estimate the value of a business entity.
Financial managers use market capitalization (also known as market cap), book value, (valuation of expected) future earnings, and many more methods and measurements to determine company valuation. Book value(s) represent the accounting and historical values, while market value(s) represent the current values. The valuation principle states that the value of an asset is equal to the present value of its expected earnings. This means that the current values are determined by future expectations.
Common methods utilized in business valuation can be assembled into several generalized approaches. Although not 100% inclusive, a valuation analyst can and will utilize these methods in each approach. Some consist as follows:
- The Asset-Based Approach consists of the book value method and the adjusted net-asset method. In addition, the adjusted net-asset method is based on three principles: replacement cost, liquidation, and going concern.
- The Income Approach consists of the capitalization of the earnings/cash flows method and the discounted earnings/cash-flows method.
- The Market Approach consists of the guideline public company method, comparable private transaction method, dividend-paying capacity method, and the prior sales of interest in the subject business.
Additional Approaches can include Income/Asset and sanity/rationality checks. The income/asset approach primarily uses the excess earnings/treasury method and the excess earnings/reasonable rate method. The sanity/rationality checks include a Justification of the purchase and the rules of thumb. The excess earnings/treasury method can also be categorized as a hybrid method because they include in consideration both the net assets and the earnings capacity of the firm.
