| Ever wondered how external business consultants | | | | that characterise the business to be valued. |
| and valuation experts manage to attach a value to a | | | | Comparable company data could be derived from |
| business that you and your employees in most | | | | listed companies where stock prices are easily |
| probability understand better? In a few weeks they | | | | available or from past transactions where unlisted |
| come up with a price tag for a business that you have | | | | companies that were acquired. The challenge lies in |
| invested several years of your career in. Whether you | | | | identifying companies that are closest to the one being |
| are part of the operational team or the senior | | | | valued and for companies operating in niche industries, |
| management within a company contemplating buying | | | | this can be a major hurdle. |
| or selling business divisions (or the whole company), a | | | | Discounted Cash Flow (DCF) Method |
| basic understanding of the valuation process and the | | | | The most sophisticated one among its peer group, this |
| fundamental concepts involved, can make a huge | | | | method relies on future earnings potential of the |
| difference while dealing with external (or for that | | | | business. The final value is calculated as the present |
| matter internal) finance professionals. | | | | value of all future free cash flows - the key operative |
| Businesses can be complex creatures, dependent on | | | | word here being 'free cash flows'. Much of the effort |
| and driven by a myriad of macro and micro | | | | within this method is spent on arriving at these free |
| parameters that can range across industry factors, | | | | cash flows for each subsequent year over a time |
| competitive landscape, management quality, business | | | | horizon (3-5-10 years depending on the nature and |
| cycle, regulatory environment and global dynamics. | | | | predictability of the business). A couple of other key |
| Conventional asset-heavy businesses can have very | | | | words that you would encounter here include the |
| different characteristics when compared to modern | | | | Perpetuity Value and the Weighted Average Cost of |
| asset-light service oriented businesses. Considering | | | | Capital (WACC). The first one describes a lump-sum |
| these differences, the valuation method employed has | | | | value (based on an assumed 'perpetuity growth rate' |
| to take into account the most critical parameters | | | | for the business) given to the business beyond the |
| applicable for the business and assign values | | | | horizon period and the second term describing the |
| accordingly. | | | | value (in percentage) used to discount the free cash |
| Business consultants usually use a combination of | | | | flows. The detailed workings tend to get a lot more |
| valuation methods and the most common ones are | | | | complex as the valuation experts look at granular level |
| described below. | | | | data for the underlying financial parameters - sales, |
| Net Assets Value (NAV) Method | | | | costs, working capital, tax structures, depreciation/ |
| This is probably the simplest of all valuation methods | | | | amortisation etc |
| as it depends on internally sourced data from within | | | | A combination of these methods is used and weights |
| the company. And also possibly the least relevant for | | | | assigned to each method depending on its relevance |
| most businesses that are going-concerns. This is | | | | to the business and the industry. For instance, if |
| based on the net worth declared by the company and | | | | comparable companies are difficult to identify, the |
| is heavily influenced by the accounting practices | | | | CCM method will have a lower weight compared to |
| followed by the company. This method has several | | | | the DCF method. The final value recommended for |
| drawbacks, the most important being the fact that | | | | the business is a weighted average of all valuation |
| future earning potential of the business is completely | | | | methods considered for the company. |
| ignored. | | | | So, next time you bump into your friendly |
| Comparable Company Multiples Method | | | | neighbourhood finance whizkid waxing eloquent on |
| The main assumption here is that data from recent | | | | their latest valuation model, their cryptic sounding |
| transactions of companies operating in the same | | | | words will hopefully sound a little less intimidating. |
| space is accessible and fairly reflects all parameters | | | | |