Valuation

The process of determining the present value of a company or an asset

Written by

CFI Team

Updated February 20, 2022

What is Valuation?

Valuation refers to the process of determining the present value of a company or an asset. It can be done using a number of techniques. Analysts who want to place value on a company normally look at the management of the business, the prospective future earnings, the market value of the company’s assets, and its capital structure composition.

Valuation may also be used in determining a security’s fair value, which depends on the amount that a buyer is ready to pay a seller, with the assumption that both parties will enter the transaction.

During the trade of a security on an exchange, sellers and buyers will dictate the market value of a bond or stock. However, intrinsic value is a concept that refers to a security’s perceived value on the basis of future earnings or other attributes of the entity that are not related to a security’s market value. Therefore, the work of analysts when doing valuation is to know if an asset or a company is undervalued or overvalued by the market.

Valuations can be performed on assets or on liabilities such as company bonds. They are required for a number of reasons including merger and acquisition transactions, capital budgeting, investment analysis, litigation, and financial reporting.

CFI’s Business Valuation Modeling Course breaks down step-by-step the methods used by a financial analyst for business valuation.

Reasons for Performing a Business Valuation

Business valuation to a company is an important exercise since it can help in improving the company. Here are some of the reasons to perform a business valuation.

#1 Litigation

During a court case such as an injury case, divorce, or where there is an issue with the value of the business, you may need to provide proof of your company’s worth so that in case of any damages, they are based on the actual worth of your businesses and not inflated figures estimated by a lawyer.

#2 Exit strategy planning

In instances where there is a plan to sell a business, it is wise to come up with a base value for the company and then come up with a strategy to enhance the company’s profitability so as to increase its value as an exit strategy. Your business exit strategy needs to start early enough before the exit, addressing both involuntary and voluntary transfers.

A valuation with annual updates will keep the business ready for unexpected and expected sale. It will also ensure that you have correct information on the company fair market value and prevent capital loss due to lack of clarity or inaccuracies.

#3 Buying a business

Even though sellers and buyers usually have diverse opinions on the worth of the business, the real business value is what the buyers are willing to pay. A good business valuation will look at market conditions, potential income, and other similar concerns to ensure that the investment you are making is viable. It may be prudent to hire a business broker who can help you with the process.

#4 Selling a business

When you want to sell your business or company to a third party, you need to make certain that you get what it is worth. The asking price should be attractive to prospective purchasers, but you should not leave money on the table.

#5 Strategic planning

The true value of assets may not be shown with a depreciation schedule, and if there has been no adjustment of the balance sheet for various possible changes, it may be risky. Having a current valuation of the business will give you good information that will help you make better business decisions.

#6 Funding

An objective valuation is usually needed when you need to negotiate with banks or any other potential investors for funding. Professional documentation of your company’s worth is usually required since it enhances your credibility to the lenders.

#7 Selling a share in a business

For business owners, proper business valuation enables you to know the worth of your shares and be ready when you want to sell them. Just like during the sale of the business, you ought to ensure no money is left on the table and that you get good value from your share.

Key Takeaways

A valuation is a process that involves defining the fair market value of an entity. Valuations may be required in many situations, including business reorganizations, shareholder disputes, employee stock or share option plans, mergers and acquisitions, and expropriations.

Most professionals see valuations as a central basis of proper decision-making for organizations, both in the present and in the future. Even though it is not possible to predict the future, for businesses to survive, they need to prepare for uncertainty.

Business valuation is a critical financial analysis that needs to be done by a valuation expert who has appropriate qualifications. Business owners who go for low-cost valuations often miss out on the significant benefits brought by performing a full valuation analysis using certified valuation professionals. Business owners are able to negotiate a tactical sale of their entity, plan an exit strategy, acquire financing, and reduce the financial risk during litigation.

Additional Resources

Thank you for reading CFI’s guide to Valuation. To keep learning and advancing your career, the following resources will be helpful:c