How to Value a Company? - Business Valuation - Certified Experts

The valuation of a company Valuation is a comprehensive process that seeks to determine the economic value of a business based on its environment and the elements that comprise it. This process not only analyzes the company's assets and liabilities, but also considers intangible factors such as brand, personnel, technology and other key resources. In essence, valuing a company involves a thorough evaluation of all technical and economic aspects related to the business.

How is a company valued?

1. Information Gathering:
   • Fixed and Current Assets: Includes tangible assets such as property, machinery, inventory and other physical assets.
   • Liabilities: The company's debts and financial obligations are evaluated.
   • Intangible Assets: Elements such as trademark, patents, copyright and technology are considered.
   • Human Resources: The value and contribution of key personnel is analyzed.
2. Cash Flow Projection:
   • The company's future ability to generate cash flow or profits is estimated. This includes projected revenues, operating costs, capital expenditures, and changes in working capital. The projection should reflect both expected long-term growth and performance influenced by internal factors (such as operational efficiency) and external factors (such as market conditions).
3. Selection of Valuation Method:
   • Discounted Cash Flow (DCF) Method: Calculates the present value of expected future cash flows, discounted at a rate that reflects the opportunity cost of capital and the associated risk. This method is useful for obtaining a valuation based on future income-generating capacity.
   • Multiples Method: Use financial multiples (such as earnings, EBITDA, or sales multiples) to compare the company to similar companies in the market. This approach is efficient for quick, comparative valuations.
   • Balance Sheet Method (Book Value or Net Book Value): Determines the value of a company based on the book value of its net assets, adjusted for liabilities. This method provides an accounting-based perspective.
   • Mixed Method or Goodwill: It combines elements of the previous methods to offer a more complete valuation, considering the goodwill or additional value related to reputation and other intangible factors.

*We will go into more depth on the topic of valuation methods later.

1. Financial Model Development:
   • After conducting a preliminary financial analysis, a financial model tailored to the specific needs of the valuation is created. This model integrates the collected data and projections to provide an accurate estimate of the company's value.
2. Interpretation of Results:
   • The results obtained from the financial model are analyzed to establish the projected value of the company. This interpretation must be consistent with the standards and criteria of financial valuation, and take into account the results of the different methodologies applied.

Valuing a company usually requires the intervention of multidisciplinary groups, depending on the type of business, it can be listed mainly: financial, economists, actuaries, legal, fiscal and in some sectors technological and environmental experts.

There are 4 methods to value a company which tend to be the most common, with the discounted flow method being one of the most popular:

• • Discounted flows

• • multiples

• • Balance

• • Mixed or Goodwill

The process of valuing a company can vary, but it usually begins with a due diligence and creation of profile, later a preliminary financial analysis is made, which will help to shape the development of an own and unique financial model according to the own needs that arose during the analysis of the previous points, later and once the financial model is concluded, interpretation is given of the results and conclusions.

The elements of a process business valuation can be divided into:

Income Approach Discounted Cash Flow Technique (FCF) What is it?

The most popular and common technique to value companies and investment projects is with the discounted cash flow methodology, establishing free cash flows, which at the same time are discounted under the VPN which is considered as the risk rate known as Wacc(k).

The discounted cash flow technique involves calculating the value of a company by estimating the expected cash flows generate in the future, which are then adjusted to present value using an appropriate discount rate.

This method is unique in its attempt to faithfully represent the current situation of the company, by integrating all the variables that influence the creation of value, such as investments, expenses and growth.

How is Discounted Cash Flows calculated?

How is the NPV calculated?

What applications does the Free Cash Flow method have?

The method of Free Cash Flow (Free Cash Flow, FCF) has several significant applications both for internal management of the company and for evaluating its attractiveness to investors. The main applications are detailed here:

1. Applications for the Company

Financial and Operational Management:

• Share Repurchase: Free Cash Flow to the Enterprise (FCFE) can be used to repurchase outstanding shares, which can be a strategy to increase the value of existing shares and improve profitability per share. Repurchases can also indicate confidence in the company's future performance and growth prospects.
• Debt Amortization: FCFE allows the company to reduce its debt levels by paying off financial obligations early. Debt repayment can lower interest costs and improve the company's financial strength, reducing financial risk and improving its credit profile.
• New Investments: Funds generated as free cash flow can be reinvested in the business to finance new projects, expand operations or acquire strategic assets. This reinvestment capacity is crucial for sustained growth and long-term competitiveness.
• Cash Reserve: Maintaining a cash reserve is a prudent strategy to handle unforeseen events and ensure operational liquidity. A healthy free cash flow allows the company to establish adequate reserves to face economic fluctuations or emerging situations.

2. Shareholder Applications

Evaluation of Return to Investors:

• Free Cash Flow to Shareholders (FCFA): This indicator represents the amount of cash available for distribution to shareholders after making all the investments necessary to maintain and expand operations. FCFA is essential for shareholders because it reflects the amount of cash that can be used to pay dividends, make share repurchases or reinvest in the company.

Valuation and Attracting Investors:

• Value Indicator: FCFA provides a clear measure of the real value that the company can offer to its shareholders. Positive and growing free cash flow is usually a sign of a financially sound company capable of generating value for its owners, which can increase the company's attractiveness to potential investors.

3. Discounted Free Cash Flow

Company valuation:

• Present Value Calculation: Discounted Free Cash Flow (DCF) is a valuation technique that estimates the present value of a company's expected future cash flows. This method uses a discount rate that reflects the opportunity cost of capital and the level of risk associated with investing in the company.
• Determining Intrinsic Value: By discounting future cash flows to present value, the DCF method helps determine the intrinsic value of the company. This allows investors to assess whether the current share price is fair relative to the calculated value, and make informed decisions about buying or selling shares.

Financial Planning: Discounted free cash flow analysis also provides valuable information for financial and strategic planning. It allows the company and investors to evaluate the viability of investment projects and growth strategies based on future cash generation capacity.

Perpetuity and its relationship with company valuation

Perpetuity is a financial concept that refers to a constant stream of cash flows that are expected to continue indefinitely into the future, in the context of business valuation, perpetuity is often used in the discounted cash flow (DCF) method, which is one of the most common approaches to determining the value of a company.

In the discounted cash flow method, the company's expected future cash flows are projected and then discounted to the present using an appropriate discount rate as mentioned above.

In some cases, it is difficult or impractical to project a company's cash flows beyond a certain period of time, as uncertainty increases over time and long-term projections may become less reliable.

This is where perpetuity comes into play, since after a certain projection period (generally at the end of the planning horizon), it is assumed that the company will continue to generate cash flows in perpetuity at a constant rate, which simplifies the calculation of the present value of future cash flows, since a simpler valuation formula can be used to calculate the present value of a perpetual stream of cash flows.

The relationship between perpetuity and business valuation lies in the fact that perpetuity is used as a way to capture the ongoing value of a company beyond the projection period explicit in the discounted cash flow analysis.

Types of Perpetuity

The perpetuity is a financial concept that refers to a series of cash flows that extend indefinitely over time. The main types of perpetuity are:

1. Simple Perpetuity: A simple perpetuity It is a constant cash flow that is paid or received at regular intervals with no change in amount over time. Its characteristics are:

• Constant Flows: Payments or income are fixed and do not vary over time.
• Example:

• An annuity that pays $1,000 per year forever, with a discount rate of 5%, would have a present value of:

2. Growing Perpetuity: A growing perpetuity It is a perpetuity in which cash flows increase at a constant rate each period. That is, each future payment is greater than the previous one by a fixed amount or percentage. Its characteristics are:

• Constant growth: Cash flows increase at a fixed rate each period.
• Example:

• If a company pays $1,000 in the first year and these payments grow by 3% annually, with a discount rate of 7%, the present value of the growing perpetuity would be:

3. Decreasing Perpetuity: A decreasing perpetuity It is a perpetuity in which cash flows decrease at a constant rate each period. This type of perpetuity is less common and is often applied in situations where the ability to generate cash flows decreases over time. Its characteristics are:

• Constant Decrease: Cash flows decrease at a fixed rate each period.
• Application in Non-Renewable Resources: It can be found in the exploitation of non-renewable natural resources, such as mineral or oil reserves, where extraction and revenues decline over time due to the reduction in available resources.

Present Value Calculation:

• Unlike simple, growing perpetuities, calculating the present value of a declining perpetuity can be more complex and usually requires adjusting the formula to reflect the rate of decline. In some cases, a similar approach to that for a growing perpetuity can be used, but with a negative sign for the growth rate.

Example:

• In the case of a gold mine whose production decreases by 2% annually, the present value of the decreasing flows must take this decrease into account to adjust the value of future income.

Each type of perpetuity has specific applications and is used in different financial contexts. The simple perpetuity is useful for valuing constant income or payments, the growing perpetuity is ideal for situations where cash flows increase over time, and the decreasing perpetuity is applied in scenarios where income decreases due to factors such as the exploitation of non-renewable resources.

Income Approach: Multiples to Value a Company 

Valuation by multiples involves determining the value of a company using ratios obtained from similar companies. These ratios are derived from the value (or price) of comparable companies along with their key financial metrics, such as revenue, EBITDA, EBIT, SALES, net profit, among others. These ratios are implicit in the comparable companies and are applied to the key financial metrics of the company to be valued.

Therefore, to use this approach, it is necessary to have a significant set of companies comparable to the entity to be valued and the ratios of these comparable companies can be applied to the financial metrics of the target company, as long as its business is not affected by unusual circumstances.

The most commonly used financial multiples in this method are:

1. Enterprise value/EBITDA multiple: It is calculated by dividing the total value of the company (market capitalization plus net debt) by the EBITDA (earnings before interest, taxes, depreciation and amortization). This multiple is commonly used in mergers and acquisitions transactions.
2. Enterprise value/SALES multiple: It is obtained by dividing the total value of the company by the income. This multiple compares the total value of the company with its income level.

Once these multiples have been obtained from comparable companies, an average or range of these multiples is calculated and applied to the company being valued to estimate its value, it is important to note that this method has limitations and does not take into account It takes into account qualitative aspects of the company.

Cost Approach: Balance Sheet Method or Net Book Value  

The balance sheet method in company valuation is a technique that is based on the analysis of the financial statements of a company, especially its balance sheet. In this approach, it seeks to determine the value of a company by evaluating its assets, liabilities and equity. net.

For this method, all assets of the business are considered in order to calculate its value, taking into account the accounting balance, but the history or evolution that the company may have in the future is not considered. Some of the most used methods are adjusted value, actual net assets, liquidation value, substantial value and book value.

Its procedure involves the sum of all the assets of a company and the subtraction of its liabilities; In this way, the value of the company is equivalent to the value of its assets, as it is especially useful when the company has considerable assets that could be liquidated to settle its liabilities in full.

However, this approach has limitations, since it is based solely on the book value to establish the value of the company, and it does not consider the concept of the time value of money, nor other external and internal elements that affect the company or that could not be valued in books, such as intangible assets or the organizational structure, among others, which are not reflected in the accounting records.

Applications of the Balance Method

This approach is especially useful in situations where:

• The company has significant assets that can be easily liquidated.
• A valuation based on direct book value is sought, as in cases of asset sales or liquidation.
• The market for comparisons is limited or the company has few intangibles that are not well reflected in the accounting records.

Limitations of the Balance Sheet Method

• Does Not Consider the Future: The method does not assess future revenue-generating capacity or growth potential.
• Value of Intangibles: It does not adequately reflect the value of important intangibles such as brand, technology and intellectual capital.
• Qualitative Aspects: It does not consider qualitative elements such as operational efficiency, team management or customer relations.

The balance sheet method or net book value provides an estimate of a company's value based on its balance sheet, adding its assets and subtracting its liabilities. Although useful for certain purposes, this approach has limitations and must be complemented by other valuation methods that consider qualitative and future aspects of the company.

Requirements for valuing a company

In order to value a company effectively and accurately, it is crucial to meet a number of requirements and gather key information that will allow for a comprehensive assessment. Below are the key requirements for carrying out a business valuation:

1. Financial Information

• Historical Financial Statements:
  • Balance Sheet: It details the company's assets, liabilities and net worth at a specific point in time.
  • Income Statement (or Profit and Loss Account): It shows income, expenses and profits during a given period.
  • Cash Flow Statement: It presents the cash flow generated and used in operating, investing and financing activities.
• Projected Financial Statements:
  • Income and Expense Projections: Future estimates of revenues and costs, based on business expectations and plans.
  • Cash Flow Projections: Future estimates of cash inflows and outflows.

2. Information on Assets and Liabilities

• Assets:
  • Fixed Assets: Includes property, plant, equipment, and machinery.
  • Intangible Assets: Includes trademarks, patents, copyrights, and software.
  • Inventories: Detail of the goods available for sale or in process.
• Liabilities:
  • Short and Long Term Debts: Information about loans, lines of credit and other financial obligations.
  • Accounts payable: Obligations to pay suppliers and other creditors.

3. Market and Industry Information

• Sector Analysis:
  • Market Trends: Information on the dynamics and trends of the sector in which the company operates.
  • Competence: Analysis of the main competitors and their impact on the company's market position.
• Economic and Regulatory Analysis:
  • Economic Conditions: Economic factors that may affect the company, such as interest rates, inflation, and exchange rates.
  • Regulations: Compliance with industry and country-specific rules and regulations.

4. Operational and Strategic Information

• Business Model:
  • Revenue Model Description: How the company generates income and what are its main sources.
  • Growth Strategy: Expansion plans, new markets and products.
• Organizational Structure:
  • Management Team: Information on the leadership and experience of the management team.
  • Human Resources: Structure and capacity of key personnel.

5. Legal and Contractual Information

• Legal documentation:
  • Contracts and Agreements: Important contracts, partnership agreements, and leases.
  • Litigation: Information about any ongoing or potential litigation or legal dispute.
• Intellectual property:
  • Patent and Trademark Registrations: Information about the patents and trademarks owned by the company.

6. Information on External Factors

• Risks:
  • Operational Risks: Risks related to the daily operation of the company.
  • Financial Risks: Risks associated with the company's capital structure and ability to meet its financial obligations.
• Trends and Changes:
  • Consumer Trends: Changes in consumer preferences and behaviors.
  • Technological Innovations: Impact of new technologies on the sector and the company.

7. Valuation methods

• Choice of Valuation Method:
  • Discounted Cash Flow (DCF) Method: Projection of future cash flows and discount to present value.
  • Market Multiples Method: Use of financial multiples based on comparable companies.
  • Asset Valuation Method: Valuation based on the value of the company's net assets.

8. Review and Validation

• Due Diligence:
  • Information Verification: Thorough review of all information provided to ensure its accuracy and completeness.
• Review of Assumptions:
  • Validation of Assumptions: Review of assumptions used in financial projections and valuation.

Valuing a business requires a thorough collection of financial, operational, market and legal data, along with careful analysis of this data. The accuracy and usefulness of the valuation depends on the quality of the information available and the correct application of valuation methods. Ensuring that all of these requirements are complete and well documented is critical to obtaining an accurate and useful valuation.

Where or with whom to have a company valuation done?

Valuing a business is a specialized process that requires technical and financial expertise. There are several options for performing this task, depending on the complexity of the business and the purpose of the valuation. Here are the main alternatives:

1. Consulting firms and valuation firms

• Financial and Management Consultants:
  • Services: They offer business valuations as part of their financial and management consultancies. These firms have experience in carrying out complex valuations and provide detailed analysis.
• Specialized valuation firms:
  • Services: They specialize in business valuation and detailed analysis of cash flows, assets, and risks. Their approach is in-depth and tailored to specific valuation needs.

2. Investment Banks

• Services: They perform valuations in the context of mergers and acquisitions, initial public offerings (IPOs), and other financial transactions. Investment banks have specialized teams that analyze companies in detail for significant transactions.

3. Certified Public Accountants (CPA) and Accounting Firms

• Services: CPAs with valuation experience may perform valuation analyses as part of their accounting and auditing services. They are useful for valuations that require a detailed review of financial statements.

4. Independent Consultants and Financial Advisors

• Services: They offer tailored services for business valuation and can provide a more flexible approach tailored to the specific needs of the company.

5. Lawyers Specialized in Corporate Law

• Services: They can assist in the valuation of companies in the context of legal disputes, restructurings and other legal matters requiring detailed valuation.

6. Online Platforms and Valuation Software

• Services: They offer online tools for performing business valuations using specialized software. They are useful for quick and less complex valuations, although they may not provide the same level of depth as an analysis performed by experts.

Considerations When Choosing a Valuation Provider

1. Experience and Specialization: Make sure the provider has specific experience in your company's industry and the type of valuation you need.
2. Credibility and Reputation: Choose a firm or individual with a good reputation and credibility in the market.
3. Approach and Methodology: Check the approach and methodology used to ensure that they are suitable for your needs and comply with applicable accounting and valuation regulations.
4. Costs and Deadlines: Consider the cost of the service and the time required to complete the appraisal. Make sure these aspects fit into your budget and timeline.
5. Confidentiality: Make sure the provider has strict confidentiality policies to protect your company's sensitive information.

The choice of a location or professional to perform a business valuation will depend on a number of factors, including the complexity of the valuation, the available budget, and the nature of the business. Consulting with specialized firms, investment banks, CPAs, or independent advisors can provide an accurate and valuable valuation for your needs.

What is the purpose of valuing a company?

Find ways and accurate ways to identify, measure the economic / operational relationship of a company based on current and future business conditions in a set of internal and external factors.

It has to be done an analysis of administrative, legal and financial, commercial, operational and market characteristics,

Through it, you can find the profile of products and services, as well as the market opportunities and limitations offered by the company itself, as well as its strengths and weaknesses.

The main factors are:

The main purposes of valuing a business can be to:

Analysis of investments, acquisitions, placement of capital on the stock market, mergers, to evaluate and remunerate managers, compensation, dation in payment, reengineering, merger-absorption, company dissolution, administration and planning.

Benefits of valuing a company

Usually a business can have different values according to who values it, so the main benefit of doing a company valuation study is to have a partial parameter that is as impartial as possible, to make decisions in favor of investors, owners or beneficiaries.

The benefits of valuing a company fall and are born in the general purpose and objective of the interested parties, that can arise from the need to calculate the range of value that seek to be a reliable reference in a negotiation between parties, may also be subject to the objective of identifying opportunities to invest when making an assessment of indicators, or value drivers that may be of interest to the potential buyer, another purpose may be to identify the economic value on certain dates to buy at appreciation or depreciation in the capacity of "value creation."

The benefits of carrying out a company appraisal are diverse and provide very useful information for decision making:

The benefits of the Service that ANEPSA Guarantees when valuing a company are:

The added value in ANEPSA is: