Business investments are made on decisions of where and how the resources should be invested. The second logical question which crops up is from where to get the funds from. Putting it in simpler terms investment decisions are based on two basic premises of where to invest and how to invest. Risk and return are considered to be two dimensions when considering any finance decisions.
But what remains to be explored is the fact how one can ensure the expected returns. In order to get the big picture, one needs to understand the inter relationship between business valuation and finance.
Business valuation and Finance: the intricate bonding
In order to get the feel of the intricate bonding, the need to comprehend finance as an activity to ensure the source and use of fund taking into consideration the risk and return perspective are understood by most of the people of finance. However, the effect of business valuation on the prudent financial decisions is worth exploring.
Let’s start with Business Valuation
Techniques of Business Valuation
In order to understand business valuation techniques, one should realize that the valuation is based on the cash flows associated with the business. A little bit of understanding of accountancy helps. But, anyway, one should not worry much.
Let’s put it in this way. All business generates revenues which take the form of cash in most of the cases. Thus, the flow of cash decides upon the amount left with the business. The value of the cash flows can play a decisive role in the business valuation. Having understood this, the common business valuation method includes Discounted Cash Flow (DCF) analysis, market valuation, comparable Transactions method and multiples methods.
Discounted Cash Flow (DCF)
One of the most beautiful ways of business valuation takes into consideration time value of money. In this method the future cash flows associated with a particular business is discounted back to its present value.
The business valuation is arrived at by taking the NPV (net present value) of the business. NPV is the difference between the present cash inflows and cash outflow during the time period of comparison. One of the important factors which decide the DCF technique is the discount factor considered. The discount factor can be the required rate of return, cost of capital or weighted average cost of capital (WACC).
Market Valuation Method
For someone who wants to understand how much a particular company is worth, the simplest way is to value the shares of the company ( in the case of public traded companies). The large corporations registered in NYSE or NASDAQ exchanges can be valued by this process.
Being public traded company the financial information of these listed companies are easily available, as they are required to publish financial reports every year. In order to determine the business valuation, one needs to calculate the market capitalization by multiplying the number of shares outstanding for the equity market value with the price of a single share (company’s stock price).
Having got the value, reaching to business valuation only requires one to adjust for the amount that it would sell for if the company were being sold. The reason for this adjustment is to take care of the fact that buyers do not pay at par with the reflection of share prices. Thus, either the business is valued at a premium (valuation higher than the actual) or at a discount (valuation lesser than the actual).
Adjusted Present Value (APV)
This technique of business valuation based on the adjustment of the NPV is termed as Adjusted Present Value (APV). The adjustments in the calculation of NPV in this process take care of only the portion financed by equity. The financing benefit by taking into account the tax shields (as those provided by deductible interest) in the present value is factored in the calculation of APV. This mode of business valuation is mostly suitable for all equity firms.
Comparable Transactions Method
This is the one of the simplest methods of business valuation and finance and takes into consideration the key factors of transaction within two similar set of business in the industry. This method helps to analyze the key ratios of the accounts and then perform analysis by comparing the ratios.
The use of accounting ratios in the business valuation and finance can be classified as multiple methods of business valuation and finance. The most frequently used multiples for business valuation are Price-to-Earnings Multiples, Earnings multiple and EBITDA multiple.
Having understood the business valuation and finance techniques, the choice of best method depends on the situation on which the valuation is conducted. Small business valuation and finance is mainly based on mainly DCF method, whereas, for the listed corporations market valuation approach can be more appropriate. You can opt for online help if you any difficulty in understand the concept of finance and its related topics.