Your Company Is Worth As Much As Somebody Else Is Willing to Pay For It

Quick Introduction to Firm Valuation

There are several approaches to estimating the economic value of a business. The most common amongst them are discounted cash-flow analysis and comparative valuation using simple market multiples that best characterize its business such as price to earnings, price to sales, enterprise value to EBITDA, etc. and can be derived either from market averages of publicly traded stocks or from recent transaction values in the given sector. Other approaches, the so-called asset-based methods, may be looking at economic book value and liquidation value or replacement cost of industrial assets. You should always use at least two different methods to get better understanding of your firm's market value. A good idea is also to compare sum of the parts valuation results with valuation using consolidated data.

The reasons why people need to determine the value of the company can be diverse. Usually it is sellers and buyers in acquisition transactions who need to value the firm or a stake in it but company valuation is often needed in other situations as well. These can include mergers, divestments or splitting up the company, divorce and partners' litigations, estimating the value of directors' stock options in a private company, heir's tax liability calculations, etc. The fact is, however, that in principle the same valuation methods are being applied in all such instances. The major differences are only in the depth of the firm's economic analysis and resulting accuracy of its financial forecasting.

The accuracy of company market valuation largely depends on two key factors: the quality of financial forecasting and correct choice of the valuation methodology for a given economic sector and type of the firm. Although firm valuation is not an exact science, most of the valuation approaches are relatively technical and universal, whereas financial forecasting is a real art, leaving plenty of room for one's imagination. Financial forecasting and thus also the valuation should always include several possible scenarios. Nonetheless, realistic financial projections come first and are often a mooting point between opposing parties involved in the transaction.

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