Valuation
The value of a company is typically determined in connection with an acquisition, share issue or redemption of a minority interest. The subject of the valuation may be the share capital or the business. There is no absolute fair value to a company, but it depends on the stage of development of the company, the valuation methods used and the purpose for which the valuation is made. Valuation methods can be based on returns, net asset value, future cash flows, or comparable prices. Theoretically, the best result is obtained by discounting the future free cash flows to their present value.
Return-based value
P/E, EBITDA or other ratios derived from the income statement are usually based on a multi-year adjusted earnings average that includes both earnings history and forecast. The use of historical information alone does not provide a sufficiently reliable basis for valuation. When doing valuation, one has to get acquainted with the company’s goals, strategy, products and services, markets, customers and the competitive situation, resources, and business risks. The availability and price of financing also matters. Based on the analysis, the earnings trend for the forecast period is assessed and the earnings average and the required return requirement are determined. To this return-based value, non-business assets are added, and interest-bearing liabilities are deducted in order to achieve the company’s book value.
Net asset value
The net asset value of a company is calculated by deducting liabilities and tax liabilities from its assets. The net asset value can be calculated directly from the official balance sheet, in which case it corresponds to the mathematical model of the taxpayer, but a more realistic picture of the net asset value is obtained by using the market prices of the assets and taking into account possible off-balance sheet liabilities. The net asset value is usually not the same as the purchase price, as the price of an acquisition is mainly based on the company’s ability to generate profits.
Suitability of a method
All valuation methods involve a lot of assumptions and uncertainties. Different methods often give different valuations which can complicate price determination.
The value of an established company is usually almost the same no matter the method used. This is based on the fact that the forecasted business growth and earnings development are in line with history, and investments and working capital growth are very predictable. The valuation of a growth company requires longer-term forecasts aimed at finding levels of profits and cash flows that are in line with a normal growth rate. Longer-term forecasts contain stronger assumptions, which reduces the reliability of the forecasts. The weaker the reliability of the forecasts, the more unreliable the valuation method based on future cash flows is. For this reason, key figures and various multipliers derived from the income statement are commonly used in SMEs.
Valuing a start-up is particularly challenging. The valuation should be based on sufficiently well-developed earnings and cash flow projections based on reasonable assumptions. In this case, reference prices are often used, in which case the valuation is based on actual purchase prices of other similar companies.
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