Whether you are considering a merger, acquisition, sale, or seeking investors, understanding how to value a business is essential. Below is our comprehensive guide on the intricacies of business valuation.
Business valuation fundamentals
Analysing financial statements
To gain a detailed understanding of your company’s financial health, you will need to thoroughly examine your financial statements:
- The balance sheet: a snapshot portraying assets, liabilities, and equity.
- The income statement: breaks down revenue, expenses, and profits to assess how well the business operates.
- The cashflow statement: unveils cash movements across operations, investments, and financing.
This careful analysis provides a deep understanding of your financial performance, empowering stakeholders to spot trends, strengths, and vulnerabilities for making informed decisions. Scrutinising these financial statements unravels the story of a business’s financial well-being, offering a valuable tool for planning and growth.
Earnings before interest, taxes, depreciation, and amortisation (EBITDA)
EBITDA is a tool used to evaluate a business’s operational prowess. It measures a company’s operating performance and profitability and is often used by analysts, investors, and creditors to assess its financial health.
In calculating EBITDA, you make crucial adjustments to the net income, creating a better understanding of your company’s earning capacity.
Firstly, you add interest expenses back, clarifying the impact of financial obligations. You also reinstate taxes, providing a pre-tax perspective on earnings. Depreciation and amortisation, which are accounting practices that allocate the cost of assets over time, should also be reintegrated.
EBITDA identifies the core operational performance of a business by excluding these non-cash expenses, making it easier to compare it across companies and industries.
This ‘reversal’ approach to assessing earnings can provide a more accurate representation of a business’s financial strength. EBITDA is a valuable tool for those seeking a thorough insight into a company’s underlying operational efficiency and profitability.
Market analysis is imperative to understanding a business’s positioning. This is the process of examining the company’s industry and market dynamics, taking note of emerging trends, potential growth avenues, and the prevailing competitive landscape.
Inspecting the competitive dynamics to identify key players, market share distribution, and potential disruptors in your industry can provide useful insight. You can explore growth prospects by evaluating market demand and evolving consumer preferences.
To establish an in-depth benchmark, compare your business’s performance metrics with industry standards. This clarifies its relative standing and helps with strategic decision-making in an ever-evolving market.
Asset-based valuation entails evaluating a company’s tangible and intangible assets to ascertain its overall value.
Tangible assets such as properties, machinery, and equipment are assessed based on market or book value. For example, this may be useful when evaluating manufacturing, transportation, agriculture, and real estate companies.
Intangible assets like patents, intellectual property, trademarks, and proprietary technology require a more delicate approach where their contribution to future earnings must also be considered. Intangible assets may be particularly relevant when analysing technology, pharmaceutical, and biotech businesses.
Once you know your total asset value, subtract liabilities, including any debts and obligations, to yield the net asset value (NAV). This method is particularly insightful for companies with substantial tangible assets or those reliant on intellectual property.
While asset-based valuation may not capture the full spectrum of a company’s potential, it can help indicate its current and future health, especially in industries where asset value is central in determining overall worth.
Every business is unique
By combining quantitative methods like financial statement analysis with qualitative factors such as market dynamics and asset-based evaluation, you can arrive at a well-rounded valuation that reflects the true worth of a business.
Business valuation is not a one-size-fits-all endeavour. Each business is distinct, and the valuation process should be tailored to its specific circumstances.
At Pearson May, we give our clients continuous updates and support. We evaluate your tangible and liquid assets, cashflow, profits, and reputation. We can also help you in meeting with potential buyers to get the best possible deal for you.
Let us help with your valuation process. Get in touch.