There are many different forms of valuations, and some are more beneficial to different types of businesses and different specific scenarios. Here are three popular business valuation methods as well as the strengths and weaknesses of each.
Multiples or Comparables
This methodology is usually the most common approach when it comes to valuing a business. This is primarily due to its relative simplicity and ease of understanding. The valuation method is fairly basic assuming the correct inputs are obtained. The comparables approach will consider what similar businesses have sold for in the past.
Strengths
- Simple calculation method
- Easily accessible multiples for most industries
- Simple to apply
Weaknesses
- There are some industries which may not be able to find comparables
- There may be complex adjustments required in some instances where there is a unique aspect to a business
- When looking solely at this valuation method it can ignore other important factors when it comes to the value of a business
Discounted Cash Flow (DCF)
A DCF will look at the future cash flows of a business in order to determine today’s value. This means a requirement to forecast the future revenue and profit over the next 5-10 years in order to obtain a current day valuation for the business.
The DCF method is one of the most overused and misunderstood valuation methods. Forecasting can be difficult to do accurately, and therefore a buyer is most likely to ignore the long term income of the valuation and focus heavily on short term forecasts. This can make the vast majority of the valuation somewhat redundant.
Strengths
- Comprehensive analysis tool
- It is widely accepted as a standard approach to valuations
- There are many input assumptions within the valuation, so it can cover a wide variety of scenarios
Weaknesses
- Relies heavily on the variable inputs and forecasts. Inaccuracies here can cause a significantly incorrect valuation
- It is relatively simple to manipulate the outcome of a DCF to seem more favourable
- Does not suit industries which experience hyper growth or difficult to predict income
Asset Based Valuations
An asset based valuation is a bottom-up approach to the valuation of a business. It has the viewpoint that the value of the business is the sum of the parts of the business, rather than the income and revenues. It will look at plant and machinery, intellectual property, goodwill etc and base the value of the company upon the value of the parts contained within it.
This can suit businesses which are asset-heavy such as construction, vehicle rentals, furniture stores etc.
Strengths
- Beneficial for businesses with many divisions and geographical locations
- Provides support for valuation (IE - Asset valuations and depreciation schedules)
- Clearly defines the different components of value within the overall valuation
Weaknesses
- Can be complex to calculate, especially with many differing assets at different points in their life cycle
- Requires a mild understanding of other valuation methods in order to complete this valuation
