Gaining a clear understanding of the value of your business is essential for making strategic decisions. These decisions determine the future development of your assets. It is important to note that value is the result of a calculation and varies depending on the valuation method. The price someone is willing to pay may differ from the value and is usually the result of negotiations.
How do you determine value?
Enterprise value is not determined purely by the historical balance sheet, income statement and cash flow. Take, for example, a start-up with no profits and limited turnover. It is far from being assessed according to historical financial metrics alone to arrive at a value. The experience of the management, the governance model, the robustness of the business model and the potential in the market are a few key factors that have a significant impact on value. Moreover, the risk profile of the same start-up is of a completely different order than that of a more mature company. To identify these various factors, the right valuation method(s) should be applied.
Valuation method 1: yield value/income approach
In the case of the start-up, the income approach, and in particular the discounted cash flow (DCF) method would be an applicable valuation method. The DCF method is one of the most widely used valuation techniques. It involves projecting a company's future cash flows and discounting them using a discount rate that reflects the company's risk profile. The DCF method is widely recognised and is useful for growth companies, companies with cash flows to be budgeted and companies with significant future investments, among others. It provides a forward-looking perspective with an emphasis on future cash flows and the time value of money.
Valuation method 2: market approach
When historical figures provide a reliable picture of the company's potential, the market approach is often used. This approach determines the value of a company by comparing it with similar companies whose shares or activities were realised. This method uses multiples derived from similar transactions in the same sector. The most commonly used parameter is the Enterprise Value to EBITDA multiple (EV/EBITDA). The market approach is easy to understand and reflects current market conditions and risk profile. However, finding transaction data from comparable companies can be challenging.
Valuation method 3: Intrinsic/substantial value
A third possibility involves the intrinsic valuation method. This method involves adjusting the book value of assets and liabilities to their market value and is particularly relevant for companies with significant assets (e.g. real estate, substantial holdings,...) whose market value of assets exceeds their book value. Intrinsically, this method is static and therefore does not take into account the future growth of the company. Depending on the activities, however, a calculation of goodwill can be integrated.
Valuation is not an exact science; it is an art that requires skill and insight
Valuation is not a one-size-fits-all process. The context of valuation plays a crucial role in determining the right method. Moreover, understanding the story behind the numbers is essential.
“Numbers without stories are just spreadsheets, not valuations.
Stories without numbers are fairytales.”
– A. Damodaran
The valuation process presents several challenges. Common pitfalls include inaccurate financial projections, limited understanding of future investment needs, lack of comparable transactions and the subjective nature of certain assumptions. For example, the DCF method requires accurate future cash flow projections. On the other hand, the market approach depends on finding comparable transactions.
At Grant Thornton, we combine our in-depth industry knowledge with robust valuation methodologies to provide accurate and insightful valuations. Whether you are considering a sale or merger, or simply want to understand the value of your business, our dedicated team of valuation experts is ready to help you through the complexities of business valuation.
