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The value of a company
The value of a company is a multifaceted concept that encompasses much more than simply its financial assets, it extends to its reputation, its position in the market, its capacity for innovation, its human capital and its potential for future growth. Calculating this value is crucial, not only for owners and shareholders, but also for investors, financial analysts, and any party interested in the health and performance of the company, this calculation involves a comprehensive evaluation of the company's financial statements, its cash flows, its future projections, as well as external factors such as the economic and competitive environment.
Knowing the true value of a company allows you to make informed decisions about investments, mergers and acquisitions, growth strategies, resource allocation and succession plans, and provides an objective metric to measure business success and set realistic goals.
Why would it be necessary to sell my company?
The need to sell a company may arise for a variety of strategic and personal reasons; from a business perspective, the sale may be necessary to realize significant profits if the value of the company has increased significantly since its founding or acquisition.
Some cases in which the sale is necessary are:
- Possibility of obtaining benefits: In the event that the value of the company has seen a considerable increase since its establishment or acquisition, the owner could choose to sell it to obtain an attractive return on investment.
- Changes in personal situation: Owners may face personal changes, such as health issues, retirement, or the need to relocate, leading them to sell the business to pursue other areas of their lives.
- Capital requirement: If the company needs additional financing to expand, invest in new technologies or acquire other businesses, selling it could be an option to obtain the necessary resources.
- Financial problems: In the event that the company is experiencing significant financial difficulties or a decline in profitability, the owner may consider selling before the situation worsens.
- Market Changes: Changes in the market or industry could lead the owner to consider selling the company if he or she observes a drop in demand for his or her products or services.
- Absence of succession: In the absence of a clear succession plan and no family members or employees interested in taking over the company, the owner could decide to sell it.
- Investment diversification: The owners may choose to sell the company to diversify their investments and reduce the concentration of their wealth in a single asset.
- Fusions and acquisitions: For larger companies, the sale may be part of a merger or acquisition strategy to strengthen market position or improve operational efficiency.
Business valuation, how does it help in the sale of a business?
The valuation of companies plays a fundamental role in the process of selling a business by providing an objective and transparent basis to determine its value in the market, this valuation helps owners and potential buyers understand the business's potential and set realistic expectations about its sales price.
Some ways business valuation contributes to the sale of a business include:
1. Set a fair price: The valuation provides an accurate assessment of the company's value, helping owners establish a fair and competitive price that reflects their market position, assets, revenue and growth potential.
2. Informed negotiation: Both sellers and buyers can use the valuation as a tool to negotiate informedly and reach a mutually beneficial agreement, a solid valuation provides an objective basis on which to discuss and reach compromises.
3. Attract investors and buyers: A professional and well-founded valuation can increase the confidence of potential investors and buyers by demonstrating the credibility and strength of the business. This can attract a broader group of interested parties and increase your chances of closing the sale.
4. Streamline the sales process: By having a clear and detailed valuation available from the beginning, you can speed up the sales process by providing potential buyers with all the information they need to make quick, informed decisions.
5. Maximize value: A professional valuation can identify areas of opportunity to improve the value of the business prior to sale, this could include recommendations to improve operational efficiency, increase profit margins or diversify revenue.
The business valuation It is an essential tool in the process of selling a business by providing an objective evaluation of value, facilitating negotiation, increasing the confidence of investors and buyers, streamlining the sales process and maximizing the final value obtained.
Company valuation models
The fair value of your company is established by adapting the financial statements to the International Financial Reporting Standards (IFRS or IFRS), which are recognized as reference standards in the global economy, after the financial information of the company complies with the IFRS, its value can be calculated using three approaches of different valuations.
Income method
This approach is based on the premise that the value of a company is closely related to its income, a projection of cash inflows and outflows is made, which allows calculating the well-known and significant “Cash Flow”, fundamental in financial modeling, this is achieved through the “Discounted Flow Method” or “Free Cash Flow for the Company/Shares”, in order to reach a definitive value of the business.
The purpose is to evaluate the future projection of the company's value today over a finite period, considering its performance in the sector to which it belongs.
Market method
To carry out the valuation of a company using a market approach, it is necessary to carry out an exhaustive investigation of comparable transactions, as well as evaluate other similar companies, considering aspects such as the innovation of their products, among other relevant factors.
Cost method
To carry out the valuation of a brand using a cost-based approach, it is assumed that the value of the brand is equivalent to the economic resources used in its creation; however, this method has the disadvantage that the result could be both excessively high and considerably low, which makes it unsuitable if the valuation is to be used in a financial transaction.
How much is my company worth?
There are alternatives in the valuation of companies that can be used for different purposes or that, in their implementation, are more effective to evaluate different levels of risk or the characteristics of the product's income flows, this implies that we could resort to different valuation models depending on the specific circumstances. The following 4 methods are the most common and efficient:
- Book value
This method represents the most common and basic way of valuing a company, it is based on information from the organization's balance sheet, where all liabilities are subtracted from assets to determine net worth, then intangible assets and the The result is the value of the company's tangible assets.
Book value = Liabilities – Assets (- intangible assets)
- Discounted Cash Flow Analysis
This analysis seeks to calculate the value of a company considering the income it is anticipated to generate in the future, which allows it to evaluate its ability to obtain profits.
The formula used is the following:
- multiples
The multiples method is a business valuation technique that is based on comparing certain financial metrics of the company in question with those of other similar companies that are listed on the market or that have been recently sold. Financial multiples are used, such as price over earnings (P/E), price over sales (P/S), enterprise value over EBITDA (earnings before interest, taxes, depreciation and amortization), among others, to estimate the value of the company in question. The above method provides a relative valuation, as it relies on comparison with similar companies, and is commonly used in mergers and acquisitions as well as in valuations of publicly traded companies.
- Goodwill
Net worth plus goodwill
Goodwill, in a business valuation, refers to the intangible value a company has above and beyond its tangible assets and liabilities, representing the company's reputation, established clientele, supplier relationships, patents, trademarks, proprietary technology, and any other intangible assets that may contribute to the company's future success and profitability.
Goodwill is calculated by subtracting the book value of the company's net assets (tangible assets less liabilities) from the total price paid by the company in an acquisition or merger, it is essentially the difference between the market value of the company and the book value of its assets and liabilities.
In a business valuation, goodwill can be a significant component of the overall value of the enterprise, especially in industries where intangible assets play a crucial role in revenue generation and long-term growth. However, goodwill can also be susceptible to impairment if the underlying assets fail to meet expectations of future profitability. It is important to note that goodwill is not amortized on a straight-line basis, but is instead regularly assessed for potential impairments in its value.
Example of company valuation using the Free Cash Flow to Equity method
The Free Cash Flow to Equity (FCFE) method on which shareholders have a right to claim and must be discounted at the cost of capital, the equation to calculate the Free Cash Flow to Shareholders (FCFE) is: net income + depreciation – capital expenditures – change in working capital – principal payments on equity + new debt.
And the Free Cash Flow to the film suggests that all shareholders can claim it and it must be deducted from the WACC, Its formula is: FCFE + interest expenses (1 – T) + principal payments – new debt + preferred dividends
The growth rate “g” can be derived from the company’s history or from analysts’ expectations about its future performance in the industry, it can also be related to the company’s and industry’s fundamentals, such as book value, dividends, ROE (return on equity), ROI (return on investment), D/E (debt to equity ratio), among other indicators.
The value of a firm can be expressed as the present value of the expected free cash flows to the firm (FCFF), as follows:
If the company reaches its maturity stage after “x” years and then starts growing at a constant rate, the value of the company can be expressed as:
Suppose the “Example” company has the following financial data:
- Free Cash Flow for Year 1 (FCF-1): $100,000
- Estimated growth rate of cash flows after year 1 (g): 3%
- Discount rate (interest rate): 10%
Steps to calculate the valuation of the “Example” company using the discounted cash flow method:
- Calculate future cash flows:
– FCF2 = FCF1 * (1 + g) = $100,000 * (1 + 0.03) = $103,000
– FCF3 = FCF2 * (1 + g) = $103,000 * (1 + 0.03) = $106,090
– And so on for future years.
- Calculate the present value of future cash flows:
– VP = FCF1 / (1 + r) + FCF2 / (1 + r)^2 + FCF3 / (1 + r)^3 + …
– VP = $100,000 / (1 + 0.10) + $103,000 / (1 + 0.10)^2 + $106,090 / (1 + 0.10)^3 + …
- Add up all the present values of the future cash flows to get the total value of the “Example” company.
- The final result will be the present value of all expected future cash flows of the “Example” company discounted at the discount rate of 10%.
This present value will represent the valuation of the “Example” company using the discounted cash flow method. It is important to note that this example is simplified and in practice, the valuation may involve additional and more detailed considerations.
