25 Jun BUSINESS VALUATION (APPROACH AND METHODOLOGY)
APPROACH AND METHODOLOGY – BUSINESS VALUATION
Business valuations is a process of determining the economic value of a company or transaction. Business valuation can be used to determine the fair value of a business for a variety of reasons as sale prospects, mergers and dissolution’s proceedings.
BUSINESS VALUATION APPROACH
Step 1: Planning
Business valuation requires detailed planning given its subjectivity and use of extensive judgements based of professional experience and observations. During planning for the business valuation, the following need to be clearly identified;
- The reason for business valuation,
- Information required in order to perform reasonable valuation;
- Identification of stakeholders and users of the valuation report
Step 2: Adjusting the historical financial statements
While financial statements are a business record of historical financial information of the business performance and position, valuation is mostly done in order to measure future economic benefits for the company. Valuation date in practical terms is not necessarily in line with the financial year end of the company as such historical financial information might have to be adjusted to align with the valuation date.
Adjustment to the historical financial statements is to be necessitated by the following key aspects;
- The valuation date,
- Future plans taking in to account new discontinued plans,
- The objective of the intended users of the report,
- And changes in the economic and market circumstances.
Historical information is vital in order to measure the company past performances in terms of trend and profile. The common approach is to have a minimum of 3 years historical information in other to test for reliability of performance.
Step 3: Choosing the business valuation methods
Choosing the business valuation method is dependent on the number of factors which need careful approach before coming to a decision of the method to adopt. The following factors are critical;
- The kind of business – some business are in nature of wealth accumulation than earning of return and for such assets are key to valuation than income.
- Availability of the information – for new businesses it may not have 3 years historical information and therefore valuation can only be done using latest information on the financial statements.
- Investor’s preference – Investor maybe of preference to a particular method which best serves their investment strategy and as such it being the method to adopt when doing valuation.
All known business valuation methods fall under one or more of these fundamental approaches:
- Cash flow Approach (both past and future)
- Net Assets Valuation Approach – At the Valuation Date
- Price Earnings Approach – Income based (both past and future)
Step 4: Number crunching: applying the selected business valuation methods
With the relevant data assembled and your choices of the business valuation methods made, calculating your business value should produce accurate and easily justifiable results.
Some methodology like cash flow and price earnings require risk adjustment mechanism which should be tested for validity in order to produce more reliable results.
Step 5: Reaching the business value conclusion
Finally, with the results from the selected valuation methods available, you can make the decision of what the business is worth. This is called the business value mixture. Since no one valuation method provides the definitive answer, you may decide to use several results from the various methods to form your opinion of what the business is worth.
Since the various business valuation methods you have chosen may produce somewhat different results, concluding the business value requires that these differences be reconciled.