BUSINESS VALUATION METHODS
There are a number of different methods used to value business in today’s market place, depending upon the size, profitability and nature of the business being valued.
Ultimately, valuations attempt to valve the future maintainable profits of an enterprise. Generally the market accepts the latest year’s profit as a basis for valuing small t o medium sized businesses, whereas for large businesses, the average of the last two or three years profit together with a detailed and realistic operating budget may be preferred.
Asset valuation method
Under-performing businesses is not commensurate with the capital invested in the business by way of plant and stock arte valued according to the asset valuation method.
There is not goodwill component and the value of the plant and equipment (usually at current market value) and stock.
This method is used when other valuation methods give a value that is less than the net tangle assets of a business. This is based on the concept that a owner is highly unlikely to sell his business for less than he can receive by a of an orderly disposal of the business assets.
The methods a comjapny use to value the cost of inventory have a direct effect on the business balance sheet, income statements and the cash flows.
Three methods are widely used to value such costs. They are:
First- in- first- out (FIFO)
Last – in- first – out (LIFO)
Average cost.
Stock is valued at invoice cost, but may be discounted depending upon that amount of show-moving or dead stock.
Plant and equipment is usually valued by an independent valuer.
Discounted Cash Flow Method
This method is favoured by the large accounting firms, although it is generally not applicable to small and medium business. In theory it is one of the best valuation methods. It attempts to put a value in an enterprise.
A DCF valuation is based on the concept that thee value of a business depends on the future net cash flow of the business discounted back to present value at an appropriate discount rte.
Future cash flow consists of tow elements:
1The net cash amounts generated each year.
2The net cash expected from the ultimate sale of the business at a point in the nature.
This method is useful where future cash flows can be predicted
with reasonable accuracy, such as winning company has a
history of regular cash flows.
Unfortunately, it is generally not suitable for valuing most
other small to medium companies because of the difficulty of
establishing cash flows some years in the future, the difficulty
of estimating the sale price of the business in the future and the difficulty of assessing a suitable discount rate.