The topic of business valuation is frequently discussed in corporate finance. The valuation of a business is the process of determining the current worth of a business, using objective measures, and evaluating all aspects of the business. This process is usually considered when a business is looking to liquidate, be put on sale, or for mergers and acquisitions of other businesses.

A business valuation might include an analysis of the company’s management, its capital state and structure, future revenue projections, and both physical and intellectual assets. The tools used for valuation can vary among evaluators, businesses, and industries. Common approaches to business valuation include a review of financial statements, discounting cash flow models, projected revenue models, projected profit, asset analysis, and balance sheets.

Valuation is also important for tax reporting. The Internal Revenue Service (IRS) requires that a business is valued based on its fair market value. Some tax-related events such as sale, purchase or gifting of shares of a company will be taxed depending on valuation.

Special Considerations: Methods of Valuation

You’ll learn about several methods of evaluation below. 

1. Market Capitalization

This is considered the simplest method of business valuation. It is calculated by multiplying the company’s share price by its total number of shares outstanding.

2. Times Revenue Method

This method is based on a stream of revenues generated over a certain period of time is applied to a multiplier which depends on the industry and economic environment. For example, a tech company may be valued at 3x revenue, while a service firm may be valued at 0.5x revenue. These vary for many reasons.

3. Earnings Multiplier

IThis method may be used to get a more accurate picture of the real value of a company, since a company’s profits are a more reliable indicator of its financial success than sales revenue is. The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period of time. This way an investor can have a more accurate estimate of future earnings.

4. Discounted Cash Flow (DCF) Method

This method is based on projections of future cash flows, which are adjusted to get the current market value of the company. The main difference between the discounted cash flow method and the profit multiplier method is that it takes inflation into consideration to calculate the present value. This is often something overlooked in primary evaluations.

5. Book Value

This is the value of shareholders’ equity of a business as shown on the balance sheet statement. In other words you look at the statement’s assets minus the liabilities to reach the total value.

6. Liquidation Value

This value is the net cash that a business will receive if its assets were liquidated and liabilities were paid off today.

This is by no means an exhaustive list of the business valuation methods in use today. Other methods include replacement value, breakup value, asset-based valuation and still many more.