Welcome back to our study of the different kinds of valuations for a company. Last time we talked about Asset Valuation, Capitalization of Income Valuation, and the Market Approach Valuation. You can read Part 1 of How to Value a Company here. This time we’ll be talking about an additional four types of valuation.
Owner Benefit Valuation
This form of valuation focuses on the cash flow of the company, and is most often used for a business’s valuation when their primary value is their ability to generate cash flow and profits. This type of valuation uses a fairly simple formula, using cash flow to create an owner benefit value, and multiplying that against the industry standard to get the market value. This valuation metric is most commonly used in main street America businesses. A few things can alter the formula:
- If there are expenses that are non-requisite or non-recurring to the operation of the company. These types of expenses are oftentimes added to the tax return cash flow.
- Non-cash expenses such as depreciation and amortization may be added to the cash flow as well.
Book Value Valuation
A book value valuation of a company looks at the actual book value of company: its current and long term assets less its liabilities. . While Book Value may be an accurate reflection based on GAAP accounting, it rarely reflects the Fair Market Value of the business. In addition there are three other major values that are factored with assets:
- Their depreciations due to age, useful lifespan, or decline of value (as with an IP).
- Their planned amortizations with the acquisition of the asset – usually 15 yrs.
- In the event of a limited natural resource, the reduction of amount as depletions.
Liquidation Value Valuation
A liquidation value valuation is the “fire sale” scenario: if your business was to go out of business, what could you sell off? Liquidation value doesn’t look to cash flow, profits, or intangible assets such as the business’s brand, IPs, or goodwill. This valuation is useful for a company that is going out of business as opposed to selling. Keep in mind that some assets are worth more than others and that liquidation can take 2 forms; auction and orderly liquidation:
- Cash, short-term liquid investments, and property, plant, and equipment wired and plumbed (PP&E) have close to 100% value, with equipment being somewhat lower due to faster depreciation.
- Accounts receivable, inventory, and long-term investments (such as owed debt, investments in businesses, and non-liquid investments) will usually have a lower recovery, usually around 75-90%.
- Goodwill, intellectual property, and brand recognition have little or any recovery value unless the business has an established brand, client list and active URL.
Discounted Future Earnings Approach
This type of valuation uses a little bit of time travel, forecasting the earnings and terminal value (anticipated value of an asset assuming stable growth), and then rewinding time to the present by discounting this future earnings and value. Factors here are:
- Terminal Value: the anticipated value of an asset in the future assuming stable growth.
- Future Earnings: estimated earnings based on a projection of current earnings.
- Discount Rate: the rate at which the future earnings and terminal value are scaled back to the current year.
That’s it for part two! Keep an eye up for the next in the series, dealing with real world business valuation for real world buyers. If you’re interested in getting your business or a potential buy valued, please contact George & Company. We’ve got the credentials, experience and the information to make the right valuation for your company.