Learn about the Process of Calculating the Valuation of the Company

Are you running a business and want to get your company valued or if in case you want to raise an investor in the company and the investor has given you a condition to get your business valued beforehand in order to receive the funds, then you must be well aware of the process of the company valuation. Let’s move into its minute details. 

Introduction to the Company Valuation 

What is the valuation of a company?

As the name connotes, it is a process where the financial worth of the company is calculated, which gives insight into the overall liabilities, finances and the assets held by the company. Valuation of the Company is an important piece of the information as it gives insight to the investors, stakeholders and the owners of the company into its overall worth. 

At the same time, the valuation of the company is also essential for someone who wants to monitor the financial activities of the company. Obtaining the information of a listed company is relatively easier as compared to the an unlisted company whose shares are not listed on any of the stock exchanges. 

Factors essential for the Valuation of the Company 

There are some factors that are to be complied with while calculating the Valuation of a company and eliminating any unnecessary information can result in obtaining the perfect set of the valuation of the company. These factors are:  

• Market Conditions: Due to the ignoring of the market conditions and vetting the valuation of the company in isolation from such conditions may result in the error in the valuation. 

• Updated Information: Due to the fact that the information is not updated, it may result in a wrong valuation of the company. Therefore, it is imperative that the information be updated and validated to avoid any chances of error. 

• Emotions: Selling the company in a hiffy jiffy may result in an error in the valuation of the company, as due to the urgency of the situation may important aspects such as the price conditions and market conditions may be ignored, thereby resulting in an erroneous valuation of the company. 

Benefits of the Company Valuation 

• Investors: With the right amount of valuation of the company, it gives the investors the right amount of confidence to invest in the right capital in the company. 

• Creditors: Creditors are the backbone of a business and the valuation of the company gives them the right confidence, as with the case of the investors, that the company is able to repay all their debts and loans. 

• Regulators: The valuation of the company, which has been done by the registered valuers or the merchant bankers, gives a good understanding that all the applicable rules and regulations have been followed. 

• Decisions: A Valuation Report provides the key insight into the minute financial details of the company, thereby giving the management of the company an edge to make and take informed decisions. 

Limitations of the Company Valuation 

• Difficulty in Applying One Valuation Methodology: There is no single straightjacket valuation method that can be arrived in order to arrive at the correct valuation of the company. It is essential that a combination of the various valuation methods be applied in order to arrive at the true valuation of the company. 

• Difficulty in different Methods: The valuation methods that are used for the valuation of the company (which has been discussed in detail below) range from easy to difficult, which makes it difficult to comprehend and arrive at the valuation of the company. 

Understanding the Valuation Models for the Company 

• Absolute Valuation Model: In this model of the company valuation, an attempt is made to arrive at the true value of the investment, which is based on the fundamentals and is taken into consideration. This is why the valuer is required to focus on different aspects such as the growth rate, dividends for the company and the cash flows. The methods of the valuation which fall under this model are Discounted Cash Flow, Asset Based Model and the Dividend Discount Model (these methods have been discussed in the preceding sections of this Article) 

• Relative Valuation Model: In this model of the company valuation, a comparison of the companies in question to the other companies working in the same industry. This method calculates the ratios and the multiples, such as comparing the multiples of similar companies and the price-to-earnings ratio.  

Methods of the Company Valuation Calculator

Comparable Method

In this method of valuation, two sets of methodologies are covered: the Comparable Company Analysis and the Comparable Transaction Analysis. In the case of the Comparable Company Analysis, the industries that are working in the same sector, while on the other hand, the Comparable Transaction Analysis uses the transactions from the same industries. 

Asset Approach

The Asset Approach is also known as the Net Asset Value and it is one of the easiest ways to understand the calculation of the company. The most important element of calculating NAV is to calculate the Fair Market Value of each asset, including depreciating and non-depreciating assets. Though the fair market value of the non-depreciating assets differs from the purchase price of the asset. 

This methodology is used to value a company that has higher tangible assets, as it is easier to calculate the fair value rather than the intangible assets. The idea behind this methodology is to see if the value of the asset is close to its replacement value in order to arrive at the value of the stock. The formula for ascertaining the NAV. 

Net Asset Value or NAV = Fair Value of all the Assets of the Company – Sum of all the outstanding liabilities of the Company.

Income Approach

This methodology of the valuation of the company is also known as the Discounted Cash Flow, wherein the intrinsic value of the company is obtained by discounting the expected future cash flows and this discounting of the future cash flows is done by using the cost of the capital asset of the company. As soon as these cash flows are discounted to the present value, the investor will be able to find out the value of the stock, which in turn helps the company in understanding if the company is overvalued, undervalued or at par. 

Market Approach

This method is also known as the Relative Valuation Method and it is known as the most common technique for the valuation of stocks. By comparing the value of the company with similar assets, which are based on important metrics such as the P/E Ratio, P/B Ratio, PEG Ratio, EV (these methodologies have been discussed in detail below), etc, for evaluating the values of the stocks. These different methodologies give a better understanding of the performance of the company as they differ in size.  

The different parameters that are used for calculating the valuation of the company under the Market Approach are: 

• PS Ratio (Price to Sales Ratio): In this methodology, the PS Ratio is calculated by dividing the Market Capitalisation of the Company (which is the Share Price X Total Number of Shares) by the total annual sales of the company. Alternatively, this can also be calculated per share by dividing the Share price by the Net Annual Sales of the Company per share.

PS Ratio = Stock Price / Net Annual Sales of the Company per share. 

The Sale/Price Ratio is a much easier concept as compared to the PE Ratio, as the sales figure is not affected by the changes in the capital structure. In a true sense, the P/S Ratio comes into play when no consistent profits are there. 

• PE Ratio (Price to Earnings Ratio): This method is also known as the Price/Earnings Ratio and in this method, the stock price is divided by the Earnings Per Share. This method is used in order to calculate if the stock is under-valued or over-valued. 

PE Ratio = Stock Price / Earnings Per Share 

In this method, the Profit After Tax is used as the multiple to obtain the estimate of the value of the equity, though there is a major issue in using this method as the Profit After Tax is subject to change and adjusted by the multiple accounting methods and the tools which in turn may result in inaccurate results. 

• PBV Ratio (Price to Book Value Ratio): This method represents the PBV Ratio, which means the price to book value ratio that denotes how expensive the stock has become. This method is mostly preferred by value investors and market analysts. 

PBV Ratio = Stock Price / Book Value of the Stock 

If it is assumed that the PBV Ratio is 2, then it means that the stock price is 20 for every stock with a book value of Rs. 10. The only drawback of this method is that it fails to incorporate the future earnings and the intangible assets of the company. 

• EBITDA (Earnings Before Interest, Tax and Amortisation): This method is considered the most reliable, as the earnings in this method are considered before calculating the interest, tax, amotisation or loan. This method is not liable to change due to the change in the capital structure, rates of the taxes and the non-operating income. 

EBITDA to Sales Ratio = EBITDA / Net Sales of the Company. 

Weighted Average Method

In this methodology of the company valuation, an estimation of the fair market value of the portfolio of assets is determined by individually valuing each of the assets by assigning a weight to the assets that is based on the importance within the portfolio and then multiplying the value of each asset to its weight and then summing up all these products in order to obtain the overall value of the portfolio. 

Sum of the Parts Valuation (SOTP)

In this methodology of the company valuation, the companies with different subsidiaries and the segments are obtained by identifying each of these subsidiaries or segments as a separate entity by using the appropriate methods and then adding the fair values of these segments and segments to obtain the value of the company. 

Book Value 

This method calculates the valuation of the company from its book value, collected from the available data on the balance sheet of the company. The Book Value is calculated by subtracting the liabilities of the company from its assets and then evaluating the equity of the shareholders and for this purpose, it deducts the value of the intangibles for valuing the tangible assets of the company. 

Times Revenue Method 

This method is known as the simplest approach as it is used to estimate the value of a company based on the annual revenue of the company. This method is commonly used by small businesses, start-ups and companies which has very limited data or earnings. This method is based on multiplying the company’s revenue by the predetermined multiple to arrive at the estimated value. This method is used in combination with the other valuation multiples in order to arrive at a more accurate estimate as it is a relatively easier concept. 

Earnings Multiplier

This method is considered a more accurate method of valuing a company’s worth as the profit of the company is more reliable than the success of the company’s revenue. In this method, the company’s earnings share is compared to the market value of its shares and a multiple is then applied to the earnings to estimate its value. The multiple is derived from the valuation of similar companies in the industry. 

The formula for this Rule runs as:

Business Value = Earnings of a Business * Multiplier 

Process of the Valuation of the Company

• Valuation Purpose: Drawing the purpose of the valuation is the first step in the valuation process of the valuation of the company. 

• Gathering Information: The second step in the process is to gather all the necessary information that is required to prepare the valuation report.

• Financial Analysis: The next step in the process is to analyse the financial data of the company and then make all the desired adjustments to arrive at the true valuation of the company. 

• Getting the insight of the Company: After making all the adjustments, it is imperative that the insights into the industry or the sector are obtained for understanding the market trends prevalent in the industry.  

• Anticipating the Company’s Performance: After getting the insights of the company, the anticipated prospects of the company are required to be drawn up. 

• Applying the relevant Valuation Method: As we have already discussed in detail, no single method can produce the desired results; thus, it is essential that the appropriate valuation methodology must be applied. 

• Preparation of the Report: At the end, after applying the relevant valuation methodology, the report will be prepared. 

Examples of the Valuation of the Company

Scenario 1:

Let’s assume that the current market price of ABC Ltd. is Rs. 190 per share. Their terminal cash flow is Rs. 300 per share for the next five years and the cost of the capital is 10%.

If the Discounted Cash Flow is to be applied the value per share would become Rs. 186.27 i.e. Rs. 300/(1 + 0.10) ^ 5], the market price per share us Rs. 190 and the shares of the company can be brought as the market price of the share is lower than the intrinsic value. In simple terms, undervaluation gives a buying opportunity and on the other hand over overvaluation indicates selling. 

Scenario 2:

The average Profit to Equity Ratio of the automobile industry is 5. The share price of the NITS company is Rs. 100, and its earnings per share are Rs. 40 and on the other hand, the share price of company Birk is Rs. 80 and the earnings per share are Rs. 10. The Profit to Equity Ratio of NITS is 25, i.e., 100/40 and the Profit to Equity Ratio of Birks is 8, i.e. 80/10. 

Company NITS has a low P/E Ratio while the Birks Company has a high P/E Ratio. Hence, it can be said that NITS is undervalued and good for the investors and Birks is overvalued which is not a good option for the investors. 

Different Regulations governing the Valuation of the Company 

• Income Tax Act, 1961: The Income Tax Tribunal is the regulatory body that has been established for managing and acting as the watchdog for the income generated from different sources. The Income Tax Tribunal is also required to curb the circulation of any black money in the market and this is why it has mandated to provide the Company Valuation be provided for accounting for any capital gains that have been incurred. 

• Companies Act, 2013: This legislation is an umbrella legislation that looks after the process right from the formation of the company till the time the entity is dissolved. The Valuation of the Company is required in the cases of the issue of sweat equity shares, demergers, mergers, or the issuance of ESOPs. 

• Indian Accounting Standard: The Indian Accounting Standard (Ind AS) is a standard set for accounting the annual finances of the organisation and this is why it is mandatory for an organisation to check the valuation of their business to file for the annual accounts. 

• Reserve Bank of India: The Reserve Bank of India is a government organisation that is responsible for the maintenance of the cash flow and inflation in the country. RBI orders the companies to present their value for checking the loan-to-value ratios. 

• Securities and Exchange Board of India: Securities and Exchange Board of India, also known as SEBI, is the watchdog for looking after the listing of securities on the stock exchange and thereby curbing the practices that can prove to be detrimental and against the norms set by the SEBI. 

• Insolvency and Bankruptcy Code, 2016: This legislation is set up to swiftly complete the process of the winding up of companies. This is why it is essential that the value of the company is known for preparing the best resolution plan for the company. 

Conclusion 

The Valuation of the Company is the process by which the worth of a company is derived. Though there is no straightjacket formula to apply for arriving at the true value of the company but a combination of different methods can be applied to know the true worth of a company, as the company valuation plays an important role in attracting the necessary funds and assistance to the company. 

Frequently Asked Questions 

Q1. What is the formula for the valuation of a company?

Ans1. Market Capitalisation is considered the simplest and best method for the valuation of the business and it is calculated by multiplying the share price of the company by its total number of outstanding shares. 

Q2. How do I calculate how much a company is worth?

Ans2. The value of the company can be obtained bu adding the value of everything which is owned by the company by including all their equipment and inventory and then subtracting any debts and liabilities. 

Q3. Is a business worth 3 times profits?

Ans3. Normally, the small business is only 1 or 2 times its annual profits. 

Q4. How to calculate private company valuation?

Ans4. A private company is valued by using the Discounted Cash Flow and Comparable Company Analysis. 

Q5. What are the top 3 valuation methods?

Ans5. The top 3 valuation methods are Discounted Cash Flow, Comparable Company Analysis, and Precedent Transaction Analysis.

Q6. What is the full form of EBITDA?

Ans6. The full form of the EBITDA is Earnings Before Interest, Taxes, Depreciation, and Amortization. 

Q7. How do you calculate fair value of a company?

Ans7. The fair value of the company is calculated by using the formula Fair Value = EPS * EPS Growth Rate.

Q8. How to calculate P/E Ratio?

Ans8. The P/E Ratio is calculated by P/E Ratio = Stock Price / EPS. 

Q9. How to calculate EBITDA?

Ans9. The EBITDA is calculated by Net Income + Interest + Taxes + Amortisation 

Q10. What is the formula for COGS?

Ans10. The formula for COGS is COGS = (beginning inventory + purchase) – ending inventory. 

Q11. What is the company valuation formula?

Ans11. The simplest company valuation formula is the Market Capitalization, which is calculated by multiplying the share price of the company by its total number of outstanding shares. However, other methods such as Discounted Cash Flow (DCF) and Asset-Based Models can also be used depending on the company’s situation.

Q12. What are the different company valuation methods?

Ans12. There are several company valuation methods, including Discounted Cash Flow (DCF), Comparable Company Analysis, Asset-Based Models, and Market Approaches like the Price-to-Earnings (P/E) ratio. Each method provides a different perspective on the company’s financial worth, depending on its assets, industry, and financial performance.

Q13. How do you find the valuation of a company?

Ans13. To find the valuation of a company, you can use various approaches, including the Discounted Cash Flow (DCF) method, comparable company analysis, or asset-based valuation. The appropriate method depends on the company’s size, assets, and growth potential. Calculating company value often involves considering both qualitative and quantitative data.

Q14. What does company valuation mean?

Ans14. Company valuation refers to the process of determining the financial worth of a business. It involves assessing a company’s assets, liabilities, market position, and potential for future growth. The value can be estimated using different valuation methods to provide insight for investors, creditors, and company management.

Q15. What are company valuation techniques based on revenue?

Ans15.Company valuation based on revenue often involves methods like the Price-to-Sales (P/S) ratio or comparing revenue multiples of similar companies. These techniques assess how much investors are willing to pay for each dollar of revenue generated by the company, helping to estimate its market value.