Why Is Business Valuation Important?

By Author: Skillfin Learning
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Business valuation determines the current economic value of an organization or a business entity, using objective measures. Generally, an evaluation is done using various business valuation formulas when a company tries to sell or buy all or part of its assets or initiates a merger & acquisition of another company.

Financial analysts consider this valuation to be the primary method for a fair assessment of a business’s worth.

Business Valuation is Important for Various Reasons

Here are some of the important reasons to carry out business valuation:

Buying a Business

A comprehensive business valuation considers the factors, including potential costs, revenues, and market conditions, to ensure that buying a business will be commercially viable.

Selling a Business

Business valuation determines the net worth of any business according to the current market pricing and whether it is worth selling it.
It also ensures the asking price attracts potential buyers.

Selling a Share in a Business

When you want to sell the shares, accurate evaluation lets you know its fair value. It makes sure you get the right price for your share.

Funding

Negotiating with prospective investors requires a detailed valuation. It enhances your company's brand image and credibility in front of investors.

Strategic Planning

A company valuation helps you to strategize well and make better decisions while bringing down financial risks.

Litigation

You may need to show your company's worth in case of damages during a court case involving injury, divorce, or a situation where documenting the business's current value is required. Business valuation comes in handy during such a situation and reduces financial risk.

Business Valuation Methods

There are numerous ways of evaluating a company’s net worth. Some of those are:

Market Capitalization

Market capitalization is calculated by multiplying the value of a company's shares by the total number of shares. It is one of the simplest methods of business valuation.

Times Revenue Method

In this method, a sum of revenues generated over a particular period is applied to a multiplier according to the industry and economic environment.

Liquidation Value

The liquidation value is equivalent to the net cash received by a company if it liquidates all its assets and pays off all its liabilities today.

Book Value

If you subtract the total liabilities of a company from its total assets, you will get the book value. It is the shareholders’ equity value, as shown on the company's balance sheet statement.

Earnings Multiplier

Profits are more reliable indicators when it comes to a company's financial success. This is why the earnings multiplier provides a more accurate picture of a company's real value. It adjusts the current P/E ratio to determine the current interest rates.

Discounted Cash Flow (DCF) Method

The DCF method is about determining future cash flows that are adjusted to predict the company's current market value.

Before We Go

Business valuation is a critical financial analysis that determines the fair market value of a company. A reputable, certified valuation expert with appropriate qualifications and experience can easily perform a business valuation. You can learn business evaluation by using business valuation formula through a quality online course comprising excellent video content and mentor support.

Rajiv G. is a Strategy and Corporate Finance Consultant with 15+ years of experience. Previously, he has worked with the Strategy and Corporate Finance practice at McKinsey & Company. He has advised clients globally in multiple industries on various Strategy and Finance engagements. Prior to this, he has worked as an Equity Research Analyst with CRISIL. He is a CFA and Chartered Accountant.