Valuation of a Company

Company valuation comes in many forms. The valuation of a company involves adding the market value of a company’s assets and then subtracting its liabilities to arrive at a net valuation. This valuation is then compared to the valuation of other companies in its field, region, or even industry to determine if the company’s valuation is too high, about right, or too low. The valuation of a company may be used for business decisions such as selling, purchasing, or merging with another company. A company valuation can also be used for loan applications where the valuation of a company can be seen as an indicator of the creditworthiness of the company for receiving loans.

Why Do Companies Need Valuation? 

The valuation of a company is used as an indicator of whether the company’s current valuation matches its true valuation. In addition, valuation also helps in determining the value of a company that will have to be offered by potential investors. If a company’s valuation or its market price falls below what its real valuation should be, then it means that the assets owned by the company can be sold at a higher valuation without jeopardizing its cash flows. This valuation also helps in making decisions if one should opt to buy, sell or hold on to a company’s shares and other types of securities. It is used in making valuation when acquiring, merging, and disposing of companies, as well as in bankruptcy valuation. It is also used in valuation when using valuation for making decisions, such as liquidation valuation or reorganization valuation.

Valuation Methods

Companies may be valued using the following valuation methods:

Equity Valuation Method

This valuation method considers only equity holders in valuing a company. The valuation is determined by adding the market value of equity with the present value of the expected cash flows until all debt obligations are cleared.

Enterprise Valuation Method

This valuation method considers both equity and fixed obligation holders in valuing a company’s enterprise assets. It is calculated by multiplying the price-to-earnings ratio (P/E) of the company’s common stock with the expected future cash flows from continued operations or from a going-concern assumption.

Market Valuation Method

This valuation method considers either equity holders or creditors, in valuing a company. The valuation is determined by multiplying the P/E ratio of publicly-traded security (i.e. stock) with the expected future cash flows from continued operations or from a going-concern assumption.

Asset Valuation Method

This valuation method considers only fixed obligation holders in valuing a company’s assets. The valuation is determined by adding the market value of fixed obligations with its current book valuation, which are both included in its asset valuation.

Liquidation Valuation Method

This valuation method considers only creditors in valuing a company’s assets. Its valuation is determined by adding its expected liquidation value with the market price of its preferred stock.

Dividend Valuation Method

This valuation method establishes valuation on dividend distributions made by companies to shareholders, considering only equity holders in valuing a company. Its valuation is determined by multiplying the dividend payout ratio (DPR) with the expected future dividends made by the company and then subtracting its cost of equity.

Asset Valuation Method

This valuation method considers only fixed obligation holders in valuing a company’s assets and involves two valuation methods: asset-based valuation and earnings valuation. Asset-based valuation is computed by multiplying the expected future cash flows that will be collected from using or disposing of an asset with its current book valuation, while earnings valuation (also known as income valuation) is computed by multiplying the expected future cash flows made by a company with its weighted average cost of capital (WACC).

Book Valuation Method

This valuation method considers both equity and fixed obligation holders in valuing a company’s assets. The valuation is determined by adding the current book valuation of all company assets with its expected future cash flows from continued operations or from a going-concern assumption.

Tax Valuation Method

In this valuation method, a valuation is determined by considering the valuation effects of a company’s tax. Its valuation is computed by multiplying its valuation per share with the present value of its future after-tax cash flows.

Investment Valuation Methods

Apart from intrinsic valuation methods, investment valuation methods that are used for determining the value of investments also include:

Cost-Based Valuation Method

This valuation method considers only the liquidation value of an investment. Its valuation is determined by deducting the cost of acquisition from its current market price, which results in its net present value (NPV).

Market-Based Valuation Method

This valuation method considers only the cash flows or dividends that will be made by a company to investors, in the valuation of an investment. Its valuation is determined by multiplying the expected future cash flows or dividends made by a company with its value per share and then subtracting its cost of equity.

Capital Structure Valuation Method

This valuation method determines the valuation on debt and capital structure of companies using two methods: earnings valuation and market valuation. Earnings valuation is computed by multiplying the expected future cash flows that will be collected from using or disposing of an asset with its current market valuation. Market valuation (also known as capitalization valuation) is computed by multiplying the company’s price per share with its book value per share and then adding the present value of its long-term debt with the present value of its preferred stock.

Liquidity Valuation Method

In this valuation method, valuation is determined by considering a company’s ability to liquidate assets or pay debts on time. Its valuation is computed by multiplying the value of a company’s networking capital, equity, and non-current assets with its EBIT valuation.

Income Valuation Method

In valuation, future earnings is the most important factor in understanding valuation. This valuation method determines valuation on what investors expect to receive from investments made into companies that produce goods or services that are expected to be sold or traded. Its valuation is determined by multiplying the present value of a company’s future after-tax earnings with its valuation per share.

The Bottom Line

With a valuation, you can determine and measure the value of a company or investment according to its future cash flows and other factors. Valuation methods are often used in real estate valuation, stock valuation, valuation of bonds, and other types of valuation. However, valuation is not only applicable to businesses but is also used in valuation of companies’ intangible assets, such as goodwill and intellectual property. While valuation methods are similar among valuation types, valuation methods can be subdivided according to the valuation criteria used for determining a company’s value. In investing, valuation enables you to make informed decisions before making an investment into a business or security that has a low valuation. However, valuation is not enough because valuation should be supported by proper valuation analysis in order to reach sound business decisions.

Valuation is the process of determining a company or investment's value based on its financial performance, future prospects, and other factors. Since valuation involves a lot of judgment and analysis, valuation can be a subjective process.
The valuation of a company is computed by multiplying the valuation per share with its total number of outstanding shares.
Companies need a valuation in order to: - Assess and determine its worth and identify potential growth opportunities and threats in making business decisions. - Determine current earnings, future income, and value of the company. - Determine valuation in making an investment into a company or business opportunity. - Assess the valuation of companies that is similar to that of another company.
- To make informed decisions before investing in a company or business opportunity. - When acquiring another company's assets, you need to know its valuation so you can pay the appropriate price. - Valuation is also used in determining valuation when looking for partners or investors.
Valuation should be used in all business decisions that involve giving up resources, like money and time, to gain something of greater value. These decisions include how much to pay for assets, valuation in making an investment, valuation in deciding on a business opportunity, valuation in buying assets from another company, valuation in choosing among opportunities, valuation in determining business valuation or valuation of the company.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.