The formal process of estimating the worth of the business. Various valuation methods include Comparable Transactions Analysis, Discounted Cash Flow, Industry Rules of Thumb, and Asset-Based Evaluations. Each of these are summarized below:
Comparable Transactions Analysis
A method of determining the value of the company by obtaining data regarding other similar, recently sold companies and applying the data to the subject company. This information may not be readily available for privately owned companies.
Discounted Cash Flow
The valuation tool that looks at projected cash flows, and discounts them to present value. The discounting factor is in part determined by the Capital Asset Pricing Model.
Industry Rules of Thumb
A method to value a company by using historical transaction multiples which are then multiplied times a company's EBITDA (Earnings Before Interest, Taxes, Depreciation, and Taxes) to estimate a company's value. Rules of Thumbs can also be applied to other than EBITDA, such as a multiple times total revenue.
Asset Based Evaluations
A method to value a business that adds the value of all the company's assets and subtracts the liabilities, leaving the net Value of its assets. Different approaches to Asset-Based Valuations include Book Value, Replacement Cost, Appraised Value, Liquidation Value and Market Value. Asset-based valuation methods ignore the importance of a company's earnings and cash flow. For this reason, this valuation approach is not typically used to determine the market value of a company that is being sold.