General definition of value:
The term “value” means a benefit or a return obtained through an object or a fact. In economic terms, the value of something refers to its exchange value, meaning that the exchange value of a commodity or a service pertains to goods or finances required in return for the acquisition of a unit of such a commodity or a service. The value of an asset depends on its demand and supply. Thus, a rare commodity with high demand is worth more than an abundant commodity with low demand. However, fluctuations in supply and demand are just a few of the market-driven variables that have an impact on a product’s value.
To date, a variety of theories have been suggested on the subject of value, such as the utility theory, the labor theory of value, and the marginalist theory of value. In short, the utility theory contends that a commodity’s value depends on its utility whereas the labor theory of value grounds its value calculation on the labor spent on a commodity’s production, and the marginalist theory of value focuses on benefit derived from a product itself, regardless of other factors.
Definition and Use of Business Valuation:
The use of valuation exceeds the limits of goods and services because businesses create values that can be quantified in economic terms and exchanged on the market in the modern world of commercial expansion, industrialization, and globalization. Business valuation foresees the potential future value of a company based on its past, technical, and current records to determine its market value as accurately as possible.
Companies resort to business valuation for a variety of reasons, such as:
i) Financing requirement: A company may need stock issuance to sustain or expand its operations for raising funds. In this case, it can perform business valuation to determine its stock prices.
ii) Company merger: When companies wish to merge to expand their operations and advance the scale of their organization, they may do a business valuation in order to analyze the value of the merger, make a strategic decision, and subsequently determine the shareholding ratios of the shareholders in the new entity.
iii) Change of partners: Business valuation is necessary to determine the reserves to be paid to a retiring partner, as well as the shareholding ratio of a new partner.
iv) Compulsory change in shares: Cases such as inheritance, divorce or execution proceeding may necessitate the transfer or distribution of company shares. In this case, the company’s value is calculated to offer due shares.
Factors Affecting Company Valuation, and Methods of Calculation:
A company’s value may depend on its structure, capital, assets, management, state as a corporate body, activities, past performance, use of technology, R&D activities, current projects, recognition, and reputation, future agreements, profit potential, financial and non-financial strategies, and other industry-relevant factors (e.g. presence in the sector, market conditions, customer base, raw material supply, the sector’s place and growth potential in the market). Another key determinant is the company’s legal status. In this respect, a thorough analysis is needed on the company’s past lawsuits, ongoing disputes, legal risks, structuring, as well as the presence of a trade union, and other risks relevant to administrative & labor law.
A wide range of methods are available in business valuation, including book (balance sheet) value, liquidation value, net asset value, discounted cash flows, market value, reconstruction value, operating enterprise value, comparable value, market multipliers, multiplier analysis, amortized replacement value, price-earnings ratio, price-cash flows, and setup cost.
Most common valuation methods are as follows:
i) Net Asset Method: Active and passive assets on the company balance sheet are identified to calculate their current market values. This method enables the determination of rebuilding costs, the market value of company assets, and the gain on sale of assets.
ii) Discounted Cash Flows Method: The method discounts the existing assets and future earnings to the current value within the framework of a company’s purpose and plan of making a profit.
iii) Liquidation Value Method: The method focuses on the complete cessation of business by calculating the value remaining after deducting all the liabilities from the value acquired through the sale of company assets. In this context, liquidation costs are deducted from the readjusted equity.
iv) Market Multiplier Method: This method, also known as the multiplier analysis, calculates the value based on similar companies’ activities such as mergers and acquisitions.
v) Relative Valuation Method: Real estate investment companies generally refer to this method to calculate the value in comparison to the sales values of comparable real estates.
vi) Setup Cost Method: This is a calculation technique based on the potential cost of rebuilding all the company facilities. This method is especially preferred by manufacturers.
vii) Stock Valuation Method: In this method for public companies, a company’s value is calculated based on the price per share that arises when the company’s shares are traded on the stock exchange during its initial public offering. Even though this method is not always the best option owing to stock market volatility, it is still widely utilized, especially in brand valuation of technology companies.
Conclusion: For the reasons outlined above, business valuation is a common strategy that is essential for creating the most accurate estimation and successfully completing the transaction related to the valuation at hand. Since business valuation and consultancy require know-how and expertise, we recommend seeking professional assistance from companies or law offices providing relevant services. As part of such a consultancy service, the provider should make the necessary preparations, obtain the most relevant information on the company and its market position, select the right valuation methods, and write a valuation report on the findings. A professional team in this field can assist you in minimizing the associated risks and arriving at the most reliable results.
