ValuAdder Business Valuation Blog

Can you confine yourself to just analyzing a company’s financial statements in order to figure out its value? The answer is no.

Why? Because business value is revealed by both its earning capacity and risk. The higher the business earnings and the lower the company’s risk, the higher its value. On the other hand, a business facing significant risk is worth less even if its earnings are high.

If you look at the details of such business valuation methods as the discounted cash flow or capitalized earnings, you will notice the inputs like the discount and capitalization rates. These are used alongside the company’s earnings in order to calculate what it is worth.

One of the most intuitive ways to assess business risk is to use the multiple of discretionary earnings valuation method. In addition to business cash flow, this method requires that you score the company across a number of value factors. You enter the business cash flow and set each of the value factors to an appropriate number. Based on your factor selections, the method calculates a multiplier and then applies it to the business cash flow. The result is what the company is worth.

Risk Assessment Across a Range of Factors

The strength of the multiple of discretionary earnings method is that it enables you to conduct comprehensive risk assessment by considering a broad range of financial and operational factors. In addition to the financial performance parameters such as stability of earnings and profitability outlook, you also evaluate the company’s market position, product mix, and operational efficiency.

Quality of Management Team and Skilled Staff

Companies are built by people. So it comes as no surprise that business value is defined by the strength of its management team and skills of the staff. Is the company too dependent on its owner or does it have a seasoned management team ready to take it to the next level? Are there long-term employees with skill and motivation to help grow the company? As you make these assessments, you set the appropriate value factors which translate into the business value result.

A Turnkey Operation is Worth More

Market is seen as the ultimate judge of what a company is worth. So if the business operation is well organized and uses consistent, well documented procedures, many business buyers would consider the company a desirable acquisition target. With this heightened level of market interest, the company is likely to fetch a higher selling price. Such a business is valued higher than an operation that is hard to understand and manage.

What About Customer Concentration?

Does the company’s revenue rely on just a few customers? Should any of these important customers walk away, the company’s earnings are likely to suffer. A business with a broad customer base is less likely to sustain such reverses, and this makes it more valuable.

Market Growth vs Consolidation

Does the company compete in a segment dominated by a handful of large, well funded competitors? Then its fortunes are likely to suffer as the large players consolidate. On the other hand, a company has more options in a growing market with many smaller competitors. Being in a market like that makes the company more valuable.

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