Guess Article By: Douglas Craig, Chartered Business Valuator
I am frequently asked how a company is valued. Simply put, the value of a company is the value in today’s dollars of all the future benefits of ownership of the company.
For operating companies, the future benefit comes from the earnings and cash flow associated with the assets owned by the subject company. The earnings or cash flow that are maintainable in the future are measured and then capitalized using an appropriate capitalization rate.
Capitalizing means multiplying by the factor chosen. This capitalization rate or multiplier is essentially an assessment of the risk associated with the subject company and its ability to achieve the estimated earnings over time.
Generally speaking, the higher the risk, the lower the valuation multiplier and the lower the value of the company.
Risk is assessed both on external factors (i.e. those beyond control of management) and internal factors (i.e. those within the control of management).
For some other companies, the value comes more from assets themselves than from company’s earnings power. Examples are holding companies and real estate companies. For these companies, the assets are typically valued separately and the aggregate of the asset values forms the value of the company.
Since there are often disposition costs, including income taxes, in the realization of the value of these assets, the estimated disposition costs are deducted from the aggregate gross values of the assets in determining the value of the company.
For a company that is no longer viable as a going concern, its value is determined using a liquidation approach. This involves a determination of the value of assets that would be sold on a piecemeal basis.
The costs of closing down the company or business, including employee costs, are estimated and deducted from the liquidation value of the assets.