Valuation is the pricing a financial asset, a company or a business. There are basically two ways to do so:
- Relative Valuation (comparative): when the parameterization is based on business/operations similar to the ones that your company intends to perform.
- Intrinsic Valuation: when you forecast future incomes and bring it to the present considering the weighted medium cost of capital. Theoretically this is the ideal method hence it captures all the features of the business in analysis.
Both methods complement each other, hence the first one can reach values much different from the other, one serving as a counterpoint to another.
As for the companies, they worth as much as they can generate cash flow and future value. There are still – when applicable – the intangible value, complementing the pricing as a whole.
Modalities
Discounted Cash Flow
In this specific modality, the company value is obtained though the future cash flows projected and discounted to the present day at a rate that represents the average capital cost.
A projection is made on how the company will perform on a predetermined time. How much it will grow? When it will grow? How much of this growth means more income? How it will be financially?
When answering all this questions among others, we will be able to project the future and bring it to the present considering the currency fluctuation, inflation, etc. In other words, we estimate the amount of income that the company will make on the future and evaluate how much that worths nowadays.
Another critical factor to opt for the discounted cash flow evaluation is the business risk. The bigger the risk, the larger is the discount rate used. After all, the buyer/investor is taking all the risk, therefore must be rewarded in the future.
That way, the total value of a company are not based only on the present actives, on goods and on the brand credibility. It is based also on the potential of profit generation that our analyst will calculate that it will achieve and the risks of that forecast happen or not.
Evaluation by multiple of EBITDA
EBITDA means Earnings Before Interest, Taxes, Depreciation and Amortization. Meaning, the profit before discounting the interest (cost of the Money) or taxes (income taxes and social contribution over the net profit) depreciation and invest amortization.
The EBITDA only considers items that are included on the cash flow, stressing the operational efficiency of the company. The EBITDA is the financial indicator that parameterizes the result in the company’s cash flow.
This indicator is highly utilized in M&A operations, whenever companies are bought or merged. Including when the business is between companies from different countries, owing to the taxes over income being different from one another.
On this evaluation, the EBITDA is calculated, using the last year info or an historical average and multiply it by a standard factor from companies of the same segment in recent operations on the market.
When and how to do it?
Knowing how much your business worth is indispensable information for any company that searches for more resources to build up. Whether by a capital opening (IPO) or a merger and acquisition operation, a valuation is indispensable. Also works for societary arrangements or arbitrage.
Smart Consulting is a specialist on this kind of job and can guide you to the best approach. Get in touch with us, have a coffee and we will gladly help you.