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) what is valuation method

Valuation Method is a specific way to determine the value of a security, business, business
ownership interest or intangible assets and hence estimate its worth. Valuation can be done on
assets such as stocks, options, business enterprises or intangible assets such as patents or
trademarks. Valuation method determines the current worth and therefore is used to quantify in
terms of monetary terms considering its benefits. Valuation methods are generally of three types:
approaches that are based on the principle of substitution and consider sum of all business
investments (cost approach), sum of all future benefits (income approach), or valuation by
comparing it with the value of similar assets or businesses (market approach).

2.) common business valuation method

. Asset Valuation

Your company’s assets include tangible and intangible items. Use the book or market value of
those assets to determine your business’s worth. Count all the cash, equipment, inventory, real
estate, stocks, options, patents, trademarks, and customer relationships as you calculate the asset
valuation for your business.

2. Historical Earnings Valuation

A business’s gross income, ability to repay debt, and capitalization of cash flow or earnings
determines its current value. If your business struggles to bring in enough income to pay bills, its
value drops. Conversely, repaying debt quickly and maintaining a positive cash flow improves
your business’s value. Use all of these factors as you determine your business’s historical
earnings valuation.

3. Relative Valuation

With the relative valuation method, you determine how much similar businesses would bring if
they were sold. It compares the value of your business’s assets to the value of similar assets and
gives you a reasonable asking price.

4. Future Maintainable Earnings Valuation

The profitability of your business in the future determines its value today, and you can use the
future maintainable earnings valuation method for business valuation when profits are expected
to remain stable. To calculate your business’s future maintainable earnings valuation, evaluate its
sales, expenses, profits, and gross profits from the past three years. These figures help you
predict the future and give your business a value today.

5. Discount Cash Flow Valuation

If profits are not expected to remain stable in the future, use the discount cash flow valuation
method. It takes your business’s future net cash flows and discounts them to present day values.
With those figures, you know the discounted cash flow valuation of your business and how much
money your business assets are expected to make in the future.

For the best and most accurate results, compare two or more methods so you’re prepared for the
merger and acquisition process and can confidently stand by the value of your business

3.) 5 steps to established business worth

Five steps to establish your business worth

Business valuation is a process that follows a number of key steps starting with the definition of
the task at hand and leading to the business value conclusion. The five steps are:

1. Planning and preparation

2. Adjusting the financial statements
3. Choosing the business valuation methods
4. Applying the selected valuation methods
5. Reaching the business value conclusion

Let’s examine in more detail what happens at each step.

Step 1: Planning and preparation

Just as running a successful business takes planning and disciplined effort, effective business
valuation requires organization and attention to detail. The two key starting points toward
establishing your business worth are:

 determining why you need business valuation

 assembling all the required information

It may seem surprising at first that the valuation results are influenced by your need for business
valuation. Isn’t business value absolute? Not really. Business valuation is a process of measuring
business worth. And this process depends on two key elements: how you measure business value
and under what circumstances.

In formal terms, these elements are known as the standard of value and the premise of value.

Business value depends on how and why it’s measured

A few examples will illustrate this important point.

Let’s say you want to sell your business. Business has been good, with revenues and profits
growing each year. You plan to market the business until a suitable buyer is found. You want to
pick the best offer and are not in a hurry to sell.

In this situation your standard of value is the so-called fair market value. Your premise of value
is a business sale of 100% ownership interest, on a going concern basis. In other words, you plan
to sell your business to the highest and most suited bidder and it will continue running under the
new ownership.

Next let’s imagine that you own a small business that has developed a product of great interest to
a large public corporation. They already approached you offering to buy you out. They have
some great plans for your product and want to sell it internationally. These people are even
prepared to offer you some of their publicly traded stock. As your CPA tells you this can
significantly lower your taxable gain on the business sale.

In this scenario you have a synergistic buyer who is applying the so-called investment standard
of measuring your business value. Such buyers are often willing to pay a premium for a business
because they can realize some unique advantages through a business purchase.

Now consider a situation where the business owners need to settle a large bill with one of the
business’ creditors who is tired of waiting. There is not enough cash in the bank to cover the
amount, so business assets need to be sold quickly.

This is the case where the so-called forced liquidation premise of value may apply – business
owners don’t have enough time to look for a suitable buyer and may have to resort to a quick
auction sale.

Once you know how and under what conditions you will measure your business worth, it is time
to gather the relevant data that impacts the business value. This data may include the business
financial statements, operational procedures, marketing and business plans, customer and vendor
information, and staff records.

Business facts affect business value

Here are a few examples of how information about the quality of operation affects the business

Well-documented financial statements and tax returns are essential to demonstrate the business
earning power.

Steady, above industry norm earnings tend to translate into higher business value.

Detailed written business operating procedures make it easy to understand how the business
works, who does what, and what skills are required.
Since it is easier to take over a well-organized business, there is higher business buyer interest
and competition among them tends to increase the business selling price.

A good marketing plan provides the essential inputs into the future business earnings projections.
And accurate earnings projections are key to establishing the business value based on its income.

A look at the customer list quickly shows where the business gets its revenues. Businesses that
do not rely on a few large customers for most of their business sales tend to command a higher
selling price.

Let’s say that the business enjoys an exclusive distribution agreement with a major vendor, a key
competitive advantage. If this agreement can be transferred to the business buyer, the business
selling price is likely to be higher.

Skilled and motivated staff is essential to business success. Not surprisingly, if experienced long-
term employees stay with the business after the sale, the selling price is likely to reflect it.

Some of the information will provide immediate and useful parameters to determine the business
value. Other parts of this data, notably the company’s historical financial statements, require
adjustments to prepare inputs for the business valuation methods. We discuss the financial
statements adjustment process in the following sections.

Step 2: Adjusting the historical financial statements

Business valuation is largely an economic analysis exercise. Not surprisingly, the company
financial information provides key inputs into the process. The two main financial statements
you need for business valuation are the income statement and the balance sheet. To do a proper
job of valuing a small business, you should have 3–5 years of historic income statements and
balance sheets available.

Many small business owners manage their businesses to reduce taxable income. Yet when it
comes to valuing the business, an accurate demonstration of the full business earning potential is

Since business owners have considerable discretion in how they use the business assets as well
as what income and expenses they recognize, the company historical financial statements may
need to be recast or adjusted.

The idea is to construct an accurate relationship between the required business assets, expenses
and the levels of business income these assets are capable of producing. In general, both the
balance sheet and the income statement require recasting in order to generate inputs for use in
business valuation. Here are the most common adjustments:

 Recasting the Income Statement.

 Recasting the Balance Sheet.
Step 3: Choosing the business valuation methods
Once your data is prepared, it is time to choose the business valuation procedures. Since there are
a number of well-established methods to determine business value, it is a good idea to use
several of them to cross-check your results.

All known business valuation methods fall under one or more of these fundamental approaches:

 Asset approach
 Market approach
 Income approach

Tools to Value a Business

Find out more

The set of methods you choose to determine your business value depends upon a number of
factors. Here are some key points to consider:

 The complexity and value of the company’s asset base.

 Availability of the comparative business sale data from the market.
 Business earnings history.
 Availability of reliable business earnings projections into the future.
 Availability of data on the business cost of capital, both debt and equity.

Choosing the asset based business valuation methods

Determining the value of an asset-rich company may justify the cost and complexity of the asset-
based valuation methods, such as the asset accumulation method. In addition to valuing the
individual business assets and liabilities, the method can be helpful when allocating the business
purchase price across the individual business assets, as part of the asset purchase agreement.

However, the method requires considerable skill in individual asset and liability valuation which
often makes its application costly and time consuming.

See example:
Business Value = Assets + Business Goodwill

How the market based business valuation methods work

Market based business valuation methods focus on estimating business value by examining the
business sale transaction data available from the actual market place. There are two types of
transaction data that can be used:
 Guideline transactions involving similar public companies.
 Comparative transactions involving private companies that closely resemble the subject

The advantage of using the public guideline company data is that it is plentiful and readily
available. However, you need to be careful when selecting such data to make an “apples to
apples” comparison to a private company.

In contrast, reviewing business sales of similar private companies provides an excellent and
direct way to estimate the business value. The challenge is gathering sufficient data for a
meaningful comparison.

Regardless of which market-based method you choose, the calculations rely on a set of so-called
pricing multiples that let you estimate the business worth in comparison to some measure of the
business economic performance. Typical pricing multiples used in small business valuation

 Selling price to revenue.

 Selling price to business earnings such as net income, SDCF, EBITDA, or net cash flow.

Each pricing multiple is a ratio of the likely business selling price divided by the respective
economic performance value. So, for instance, the selling price to revenue multiple is calculated
by dividing the business selling price by business revenue.

To estimate your business value, you can use one or more of these pricing multiples. For
example, take the selling price to revenue pricing multiple and multiply it by the business annual
revenue. The result is the business selling price estimate.

Valuation multiple formulas

More sophisticated market based business valuation methods, such as the Market Comps in
ValuAdder, use business pricing rules that make an intelligent choice of which pricing multiplies
to apply when valuing a business. In addition, the Market Comps let you account for key
business attributes automatically:

 Business revenue or profits

 Inventory
 FF&E
 Tangible asset base

See example:
Valuing a Business based on Market Comps

The income based business valuation

Income based business valuation methods determine business worth based on the business
earning power. Business valuation experts widely consider these methods to be the most
accurate. All income-based business valuation methods rely on either discounting or
capitalization of some measure of business earnings.

The discounting methods, such as the ValuAdder Discounted Cash Flow, produce very accurate
results by letting you specify the details of the expected business income stream over time. The
Discounted Cash Flow method is an excellent choice for valuing a young or rapidly growing
company whose earnings vary considerably.

Alternatively, the so-called direct capitalization methods, such as the ValuAdder Multiple of
Discretionary Earnings, determine your business worth based on the business earnings and a
carefully constructed capitalization rate. The Multiple of Discretionary Earnings method is an
outstanding choice for valuing small established companies with consistent earnings and growth

See example:
How to Value a Business as Multiple of Earnings

Step 4: Number crunching: applying the selected business

valuation methods
With the relevant data assembled and your choices of the business valuation methods made,
calculating your business value should produce accurate and easily justifiable results.

One reason to use several business valuation methods is to cross-check your assumptions. For
example, if one business valuation method produces surprisingly different results, you could
review the inputs and consider if anything has been overlooked.

ValuAdder business valuation software helps you focus on the big picture of determining the
business value by automating complex calculations and letting you easily adjust and capture your
assumptions while running multiple what-if valuation scenarios.

Step 5: Reaching the business value conclusion

Finally, with the results from the selected valuation methods available, you can make the
decision of what the business is worth. This is called the business value synthesis. Since no one
valuation method provides the definitive answer, you may decide to use several results from the
various methods to form your opinion of what the business is worth.

Since the various business valuation methods you have chosen may produce somewhat different
results, concluding the business value requires that these differences be reconciled.
Business valuation experts generally use a weighting scheme to derive the business value
conclusion. The weights assigned to the results of the business valuation methods serve to rank
their relative importance in reaching the business value estimate.

Here is an example of using such a weighting scheme:

Approach Valuation Method Value Weight Weighted Value

Market Comparative business sales $1,000,000 25% $250,000
Income Discounted Cash Flow $1,200,000 25% $300,000
Income Multiple of Discretionary Earnings $1,350,000 30% $405,000
Asset Asset Accumulation $950,000 20% $190,000

The business value is just the sum of the weighted values which in this case equals $1,145,000.

While there are no hard and fast rules to determine the weights, many business valuation experts
use a number of guidelines when selecting the weights for their business value conclusion:

The Discounted Cash Flow method results are weighted heavier in the following situations:

 Reliable business earnings projections exist.

 Future business income is expected to differ substantially from the past.
 Business has a high intangible asset base, such as internally developed products and
 100% of the business ownership interest is being valued.

The Multiple of Discretionary Earnings method gets higher weights when:

 Business income prospects are consistent with past performance.

 Income growth rate forecast is thought reliable.

Market based valuation results are weighted heavier whenever:

 Relevant comparative business sale data is available.

 Minority (non-controlling) business ownership interest is being valued.
 Selling price justification is very important.

The asset based valuation results are emphasized in the weighting scheme when:

 Business is exceptionally asset-rich.

 Detailed business asset value data is available.

4.) 5 equity valuation method

a.) discounted cash flow

What Is a Discounted Cash Flow (DCF)?
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment
based on its future cash flows. DCF analysis attempts to figure out the value of a company today,
based on projections of how much money it will generate in the future.

DCF analysis finds the present value of expected future cash flows using a discount rate. A
present value estimate is then used to evaluate a potential investment. If the value calculated
through DCF is higher than the current cost of the investment, the opportunity should be

DCF is calculated as follows:

 CF = Cash Flow
 r = discount rate (WACC)
 DCF is also known as the Discounted Cash Flows Model


Discounted Cash Flow (DCF)

How Discounted Cash Flow (DCF) Works

The purpose of DCF analysis is to estimate the money an investor would receive from an
investment, adjusted for the time value of money. The time value of money assumes that a dollar
today is worth more than a dollar tomorrow.

For example, assuming 5% annual interest, $1.00 in a savings account will be worth $1.05 in a
year. Similarly, if a $1 payment is delayed for a year, its present value is $.95 because it cannot
be put in your savings account.

For investors, DCF analysis can be a handy tool that serves as a way to confirm the fair value
prices published by analysts. It requires you to consider many factors that affect a company,
including future sales growth and profit margins. You’ll also have to think about the discount
rate, which is influenced by the risk-free rate of interest, the company’s cost of capital and
potential risks to its share prices. All of this helps you gain insight into factors that drive share
price, so you’ll be able to put a more accurate price tag on the company’s stock.

A challenge with the DCF model is choosing the cash flows that will be discounted when the
investment is large, complex, or the investor cannot access the future cash flows. The valuation
of a private firm would be largely based on cash flows that will be available to the new owners.
DCF analysis based on dividends paid to minority shareholders (which are available to the
investor) for publicly traded stocks will almost always indicate that the stock is a poor value.
However, DCF can be very helpful for evaluating individual investments or projects that the
investor or firm can control and forecast with a reasonable amount of confidence.

DCF analysis also requires a discount rate that accounts for the time value of money (risk-free
rate) plus a return on the risk they are taking. Depending on the purpose of the investment, there
are different ways to find the correct discount rate.

Alternative Investments
An investor could set their DCF discount rate equal to the return they expect from an alternative
investment of similar risk. For example, Aaliyah could invest $500,000 in a new home that she
expects to be able to sell in 10 years for $750,000. Alternatively, she could invest her $500,000
in a real estate investment trust (REIT) that is expected to return 10% per year for the next 10

To simplify the example, we will assume Aaliyah is not accounting for the substitution costs of
rent or tax effects between the two investments. All she needs for her DCF analysis is the
discount rate (10%) and the future cash flow ($750,000) from the future sale of her home. This
DCF analysis only has one cash flow so the calculation will be easy.

In this example, Aaliyah should not invest in the house because her DCF analysis shows that its
future cash flows are only worth $289,157.47 today. Once tax effects, rent, and other factors are
included, Aaliyah may find that the DCF is a little closer to the current value of the home.
Although this example is oversimplified it should help illustrate some of the issues of DCF
including finding appropriate discount rates and making reliable future predictions.

Weighted Average Cost of Capital (WACC)

If a firm is evaluating a potential project, they may use the weighted average cost of capital
(WACC) as a discount rate for estimated future cash flows. The WACC is the average cost the
company pays for capital from borrowing or selling equity.

Imagine a company that could invest $50 Million in equipment for a project that is expected to
generate $15 million dollars per year for 4 years. At the end of the project, the equipment that
was used can be sold for $12 Million. If the company’s WACC is 12%, a DCF analysis can be

In this case, the company should invest in the project because the DCF analysis results in a value
that is greater than the $50 million initial investment.

Limitations of Discounted Cash Flow Model

A DCF model is powerful, but there are limitations when applied too broadly or with bad
assumptions. For example, the risk-free rate changes over time and may change over the course
of a project. Changing cost of capital or expected salvage values at the end of a project can also
invalidate the analysis once a project or investment has already started.

Applying DCF models to complicated projects or investments that the investor cannot control is
also difficult or nearly impossible. For example, imagine an investor who wants to purchase
shares in Apple Inc. (AAPL) in late 2018 and decides to use DCF to decide whether the current
share price is a fair value.

This investor must make several assumptions to complete this analysis. If she uses free cash flow
(FCF) for the model, should she add an expected growth rate? What is the right discount rate?
Are there alternatives available or should she just rely on the estimated market risk premium?
How long will she hold AAPL’s stock and what will its value be at the end of that period?
Unfortunately, there's a lack of consistent answers to these questions, and since she cannot
access AAPL’s cash flow as a minority shareholder, the model is not helpful.

Discounted Cash Flow Model (DCF) Summary

Investors can use the concept of the present value of money to determine whether future cash
flows of an investment or project are equal to or greater than the value of the initial investment.
In order to conduct a DCF analysis, an investor must make estimates about future cash flows and
the ending value of the investment, equipment, or other assets.

The investor must also determine an appropriate discount rate for the DCF model, which will
vary depending on the project or investment under consideration. If the investor cannot access
the future cash flows, or the project is very complex, DCF will not have much value and
alternative models should be employed.


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b.) comparable company analysis

A comparable company analysis (CCA) is a process used to evaluate the value of a company
using the metrics of other businesses of similar size in the same industry. Comparable company
analysis operates under the assumption that similar companies will have similar valuation
multiples, such as EV/EBITDA. Analysts compile a list of available statistics for the companies
being reviewed and calculate the valuation multiples in order to compare them.

Comparable Company Analysis (CCA)

Understanding Comparable Company Analysis (CCA)

One of the first things every banker learns is how to do a comp analysis or comparable company
analysis. The process of creating a comparable company analysis is fairly straightforward. The
information the report provides is used to determine a ballpark estimate of value for the stock
price or the firm's value.

Key Takeaways

 Comparable company analysis is the process of comparing companies based on similar

metrics to determine their enterprise value.
 A company's valuation ratio determines whether it is overvalued or undervalued. If the
ratio is high, then it is overvalued. If it is low, then the company is undervalued.
 The most common valuation measures used in comparable company analysis are
enterprise value to sales (EV/S), price to earnings (P/E), price to book (P/B), and price to
sales (P/S).

Comparable Company Analysis

Comparable company analysis starts with establishing a peer group consisting of similar
companies of similar size in the same industry or region. Investors are then able to compare a
particular company to its competitors on a relative basis. This information can be used to
determine a company's enterprise value (EV) and to calculate other ratios used to compare a
company to those in its peer group.

Relative vs. Comparable Company Analysis

There are many ways to value a company. The most common approaches are based on cash
flows and relative performance compared to peers. Models that are based on cash, such as the
discounted cash flow (DCF) model, can help analysts calculate an intrinsic value based on future
cash flows. This value is then compared to the actual market value. If the intrinsic value is higher
than the market value, the stock is undervalued. If the intrinsic value is lower than the market
value, the stock is overvalued.

In addition to intrinsic valuation, analysts like to confirm cash flow valuation with relative
comparisons, and these relative comparisons allow the analyst to develop an industry benchmark
or average.

The most common valuation measures used in comparable company analysis are enterprise value
to sales (EV/S), price to earnings (P/E), price to book (P/B), and price to sales (P/S). If the
company's valuation ratio is higher than the peer average, the company is overvalued. If the
valuation ratio is lower than the peer average, the company is undervalued. Used together,
intrinsic and relative valuation models provide a ballpark measure of valuation that can be used
to help analysts gauge the true value of a company.

Valuation and Transaction Metrics Used in Comps

Comps can also be based on transaction multiples. Transactions are recent acquisitions in the
same industry. Analysts compare multiples based on the purchase price of the company rather
than the stock. If all companies in a particular industry are selling for an average of 1.5 times
market value or 10 times earnings, it gives the analyst a way to use the same number to back into
the value of a peer company based on these benchmarks.


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c.) comparable company analysis

What Is a Comparable Transaction?

The cost of a comparable transaction is one of the major factors in estimating the value of a
company that is being considered as a merger and acquisition (M&A) target. The reasoning is the
same as that of a prospective home buyer who checks out recent sales in a neighborhood.

This is commonly referred to as a comp transaction.

Key Takeaways

 Comparable transactions are used in assessing a fair value for a corporate takeover target.
 The ideal comparable transaction is for a company in the same industry with a similar
business model.
 The fair value of the takeover target is based on its recent earnings.

Understanding the Comparable Transaction

Companies seek to acquire other companies in order to grow their businesses, gain access to
valuable resources, expand their reach, eliminate a competitor, or some combination of all of
these reasons.
In any case, overpaying for that acquisition could be disastrous. So, the company and its
investment bankers look for comparable transactions—the more recent the better. They look at
companies with a similar business model to the company being targeted. The more
comparable transaction data that are available for analysis, the easier it is to derive a fair

Conversely, a company that has become a takeover target does the same type of analysis in order
to determine whether an offer that is on the table is a good one for its own shareholders.

In either case, the comparable transaction method of valuation can help a company arrive at a
price for the acquisition that shareholders are willing to accept.

The Valuation Metric

The specific valuation metric in widespread usage for comparable transaction analysis is the EV-
to-EBITDA multiple. EV is enterprise value and EBITDA is earnings before interest, taxes,
depreciation, and amortization. In this formula, a 12-month period is used for EBITDA.

The comparable transaction valuation is generally used in conjunction with other data including
the company's discounted cash flow, price-to-earnings ratio, price-to-sales ratio, and price-to-
cash-flow ratio. Others factors are relevant to particular industries.

All of the above numbers are readily available for public companies. If the acquisition target is
not a publicly-traded company, the available data may be limited.

Real World Example of a Comparable Transaction

Becton, Dickinson and Company (BDX) filed a Form S-4 with the SEC in mid-2017 for its
intended acquisition of C.R. Bard, Inc. Both companies are developers and manufacturers of
medical devices.

The Fairness Opinion

The filing disclosed that Bard retained Goldman Sachs as a financial adviser to render a fairness
opinion for the price offered by BD. Since the healthcare supply industry had undergone
significant consolidation in recent years, Goldman Sachs had an array of comparable transaction
data at its disposal.

Nine comparable transactions from 2011 to 2016 are listed in the filing. That allowed a robust
analysis for Bard shareholders and the company's board of directors to consider for BD's
takeover offer.

Comparables are analyzed by the takeover target as well as the prospective acquirer.

Bard's financial adviser calculated the range of EV-to-LTM EBITDA multiples of the past
transactions as well as the median multiple. Comparable transaction analysis was one of several
valuation techniques analyzed for this deal, the others including price-earnings and price-
earnings-growth multiples. But it also was the leading one, as is the standard practice for mergers
and acquisitions.

The Usual Warning

Although it is standard practice, it is not considered the final word on valuing a targeted firm. In
this example, Goldman Sachs issued a disclaimer that its comparable transaction analysis, along
with the other valuation metric analyses, "do not purport to be appraisals nor do they necessarily
reflect the prices at which businesses or securities may be sold."

The deal was eventually approved at a price of $24 billion.


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d.) asset based

What Is an Asset-Based Approach?

An asset-based approach is a type of business valuation that focuses on the net asset value of a
company. The net asset value is identified by subtracting total liabilities from total assets. There
can be some room for interpretation in terms of deciding which of the company's assets and
liabilities to include in the valuation and how to measure the worth of each.

Key Takeaways

 There are several methods available for calculating the value of a company.
 An asset-based approach identifies a company’s net assets by subtracting liabilities from
 The asset-based valuation is often adjusted to calculate the net asset value of a company
based on the market value of its assets and liabilities.

Understanding an Asset-Based Approach

Identifying and maintaining awareness of the value of a company is an important responsibility
for financial executives. Overall, stakeholder and investor returns increase when a company’s
value increases and vice versa.

There are a few different ways to identify a company’s value. Two of the most common are the
equity value and enterprise value. The asset-based approach can also be used in conjunction with
these two methods or as a standalone valuation. Both equity value and enterprise value require
the use of the equity in the calculation. If a company does not have equity, analysts may use the
asset-based valuation as an alternative. Many stakeholders will also calculate the asset-based
value and use it comprehensively in valuation comparisons. The asset-based value may also be
required for private companies in certain types of analysis as added due diligence. Furthermore,
the asset-based value can also be an important consideration when a company is planning a sale
or liquidation.

Calculating Asset-Based Value

The asset-based approach uses the value of assets to calculate a business entity's valuation.

In its most basic form, the asset-based value is equivalent to the company’s book value or
shareholders’ equity. The calculation is generated by subtracting liabilities from assets.

Oftentimes, the value of assets minus liabilities can be different from the values reported on the
balance sheet due to timing and other factors. Asset-based valuations can provide latitude for
using market values rather than balance sheet values. Analysts may also include certain
intangible assets in asset-based valuations that may or may not be on the balance sheet.

Adjusting Net Assets

One of the biggest challenges in arriving at an asset-based valuation is the adjusting of net assets.
An adjusted asset-based valuation seeks to identify the market value of assets in the current
environment. Balance sheet valuations use depreciation to decrease the value of assets over time.
Thus, the book value of an asset is not necessarily equivalent to the fair market value. Other
considerations for net asset adjustments may include certain intangibles that are not fully valued
on the balance sheet or included on the balance sheet at all. Companies might not find it
necessary to value certain trade secrets but since an adjusted asset-based approach looks at what
a company could potentially sell for in the current market these intangibles would be important
to consider.

In an adjusted net asset calculation, adjustments can also be made for liabilities. Market value
adjustments can potentially increase or decrease the value of liabilities which directly affects the
calculation of adjusted net assets.


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e.) sum part of evaluation

The sum-of-the-parts valuation (SOTP) is a process of valuing a company by determining what

its aggregate divisions would be worth if they were spun off or acquired by another company.

The valuation provides a range of values for a company's equity by aggregating the standalone
value of each of its business units and arriving at a single total enterprise value (TEV). The
equity value is then derived by adjusting the company's net debt and other non-operating assets
and expenses.

The Formula for Sum-of-the-Parts Valuation – SOTP Is

SOTP=N1+N2+…+ND−NL+NAwhere:N1=Value of first segmentN2=Value of second segment
ND=net debtNL=nonoperating liabilitiesNA=nonoperating assets\begin{aligned} &\text{SOTP}
= N_1 + N_2 + \dotso + ND - NL + NA \\ &\textbf{where:}\\ &N_1=\text{Value of first
segment}\\ &N_2=\text{Value of second segment}\\ &ND=\text{net debt}\\
&NL=\text{nonoperating liabilities}\\ &NA = \text{nonoperating assets} \end{aligned}
SOTP=N1+N2+…+ND−NL+NAwhere:N1=Value of first segmentN2
=Value of second segmentND=net debtNL=nonoperating liabilitiesNA=nonoperating assets

How to Calculate Sum-of-the-Parts Valuation – SOTP

The value of each business unit or segment is derived separately and can be determined by any
number of analysis methods. For example, discounted cash flow (DCF) valuations, asset-based
valuations and multiples valuations using revenue, operating profit or profit margins are methods
utilized to value a business segment.

What Does the SOTP Tell You?

Sum-of-parts valuation, also known as breakup value analysis, helps a company understand its
true value. For example, you might hear that a young technology company is "worth more than
the sum of its parts," meaning the value of the company's divisions could be worth more if they
were sold to other companies.

In situations such as this one, larger companies have the ability to take advantage of synergies
and economies of scale unavailable to smaller companies, enabling them to maximize a
division's profitability and unlock unrealized value.
The SOTP valuation is most commonly used to value a company comprised of business units in
different industries since valuation methods differ across industries depending on the nature of
revenue. It is possible to use this valuation to defend against a hostile takeover by proving the
company is worth more as a sum of its parts. It is also possible to use this valuation in situations
where a company is being revalued after a restructuring.

Key Takeaways

 SOTP is the process of valuing a company by determining what its aggregate divisions
would be worth if they were spun off or acquired by another company.
 It is also known as breakup value analysis.
 SOTP is used to value a company comprised of business units in different industries.

Example of How to Use the Sum-of-the-Parts Valuation –

Consider United Technologies (NYSE: UTX), which said it will break the company into three
units in late 2018—an aerospace, elevator and building systems company. Using the 10-year
median enterprise value-to-EBIT (EV/EBIT) multiple for peers and 2019 operating profit
projections, the aerospace business is valued at $107 billion, the elevator business at $36 billion
and building systems business $52 billion. Thus, the total value is $194 billion. Lessing out net
debt and other items of $39 billion, the sum-of-the-parts valuation is $155 billion.

The Difference Between the SOTP and Discounted Cash

Flow – DCF
While both are valuation tools, the SOTP valuation can incorporate a discounted cash flow
(DCF) valuation. That is, valuing a segment of a company may be done with a DCF analysis.
Meanwhile, the DCF uses discounted future cash flows to value a business, project or segment.
The present value of expected future cash flows is discounted using a discount rate.

Limitations of Using Sum-of-the-Parts Valuation – SOTP

The sum-of-the-parts (SOTP) valuation involves valuing various business segments, and more
valuations come with more inputs. As well, SOTP valuations do not take into account tax
implications, notably the implications involved in a spinoff.

Learn More About the SOTP Valuation

For help on choosing the right valuation tool check out Investopedia’s guide to picking the right
valuation method.

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5.) importance of valuation methods

1. Valuations provide a baseline. Just like getting an annual physical at the doctor’s office,
regular valuations provide a baseline. They serve as an indication of what you’re doing right and
what you could be doing better. Some years your value may be up, other years it may be down a
little bit (particularly in the event of a market correction). But without knowing your baseline,
you have no solid evidence of how you’re doing. Think of a valuation as a health metric for your
business that serves to measure your business’s blood pressure.

2. Valuations help chart the course for the future. Simply put, you don’t know where to go if
you don’t know where you are. Valuations can help you determine ways to improve the business.
Perhaps a valuation will indicate the need for a technology investment or hiring an employee.
Maybe you’ll come to the realization that an expense can be reduced or eliminated. Valuations
can often help an owner make a change to the business or assist with a decision they may have
been having difficulty with.

3. Valuations measure progress. Performed regularly, valuations provide a pretty good measure
of how you’re doing compared to the path you’ve set for your business. To be most effective,
valuations should be utilized in tandem with your strategic business plan and should be referred
to as a component of any significant decision.

4. Valuations can identify gaps. A comprehensive valuation will utilize key performance
indicators (KPIs) to look at the non-financial aspects of a business that are actually the
underlying value drivers. Examples are corporate structure, client demographics, technology
usage, and firm infrastructure. KPIs are instrumental in identifying areas of potential
improvement for the business – and ultimately provide ways to increase value.

5. Valuations help you manage your business. Valuations can and should be used as a
powerful driver of how you manage your business. The purpose of a valuation is to track the
effectiveness of your strategic decision-making process and provide the ability to track
performance in terms of estimated change in value, not just in revenue. This helps you to take a
holistic look at your business and make decisions that are highly impactful for your bottom line.
It allows you to understand the subtle dynamics of your business and avoid unforeseen
consequences of seemingly insignificant decisions.

6. Valuations create accountability. Now that you’ve utilized a valuation to identify gaps and
set a path for the future (with measurable goals), you have, in essence, made yourself
accountable for achieving those goals and can create discipline around them. Remember, this
should be used as a component of your strategic business plan – because if you can measure it,
you can manage it.

7. Valuations provide a benchmark. With little to no public data available on what businesses
in this industry sell for (the vast majority of deals are never published), knowing your baseline
value can allow you to benchmark yourself (via KPIs) against your peers, as well as “Best
Practices” standards.

8. Valuations provide a perspective on price. When it comes times to transition (and all
businesses will eventually transition), your historical valuations (remember, valuations should be
an ongoing exercise) provide a starting point for price. Whether it’s an external sale or internal
next-generational transfer, you now have an idea of what your business could be worth to a
prospective buyer (though price is only one component of a deal). Owners often have an
unrealistic valuation expectation – having a baseline valuation and understanding what drives
that value can help eliminate any surprises down the road.

9. Valuations can provide the gateway to capital. If you are considering borrowing capital for
an acquisition or other business investment, any lender will want to know what leverage lies in
your business. Your valuation is the first step in the process of securing capital.

10. Valuations are part of your estate plan. For an owner, the business value typically
represents 50-70% of their personal net worth. More often than not, owners fail to diversify the
concentrated stock position they hold in their own business. Knowing how the business value
impacts your personal financials can help you better plan for your family’s future.

Unquestionably, valuations serve many purposes and go well beyond “what someone would pay
for your business”. Used properly, valuations allow you to see the inner-workings of what’s
really going on in your business. That insight puts you in a competitive position as you strive to
strengthen and increase the value and overall performance of the business.