Business valuation

The goal of business valuations is to determine the fair value of a business. There can be various reasons for conducting a business valuation, such as the purchase or sale of a business, the entry or exit of a shareholder, mergers, business contributions, or the determination of whether an investment is undervalued or overvalued. However, a company’s value is determined not only by quantitative criteria (book value, expected profit, or future discounted cash flow) but also by qualitative factors –  as is often the case with family-owned businesses that have been in the family for a long time.

To determine fair value, the following approaches are used.

Approaches

Earnings-based business valuation

• The value of a company operating on a going concern basis is determined by its earnings potential. 
• This approach focuses on the present value of sustainable and distributable future profits. 
• Valuation is driven primarily by the company's current and expected future earnings.

Market-based business valuation

• The company's value is derived using current market prices and comparable market data. 
• This approach is widely regarded as highly credible because it relies on observable market information, increasing objectivity. 
• It enables comparisons between companies within the same industry through peer group analysis.

Asset-based valuation method

• All of a company’s assets and liabilities are valued as accurately as possible
• This method is often used to evaluate a company's creditworthiness and financial stability. 
• In practice, asset-based valuation typically serves as a supplementary source of information rather than a standalone valuation method.

Basics of a balance sheet

A balance sheet serves to compare assets (use of funds) and liabilities (source of funds). Assets show how financial resources have been used, while liabilities represent the claims of creditors (debt) and the business owners (equity). Equity is the balance between assets and debt.

Assets:

• Current assets
  • Inventories
  • Cash and cash equivalents
  • Trade receivables
• Noncurrent assets
  • Property, plant, and equipment
  • Financial assets
  • Intangible assets
  • Goodwill

Liabilities:

• Debt
  • Current debt
  • Long-term debt
• Closing balance

Statement of income (SOI)

The statement of income compares a company’s revenues and expenses, thereby determining the company’s financial performance (= profit or loss).

The income statement is prepared as follows:

1. Expenses and revenues are posted to income statement accounts.
2. These income statement accounts are closed by offsetting them, and the closing balances are transferred to the income statement account.
3. The balance of the income statement account is calculated. A net income for the year is reported when revenues exceed expenses.
4. The profit or loss is posted to the equity account.

Key metrics for the income statement

• EBITDA (earnings before interest, taxes, depreciation, and amortization)
  This figure represents earnings before interest, taxes, depreciation, and amortization
• EBIT (earnings before interest and taxes)
  This refers to earnings before interest and taxes
• EBT (earnings before taxes)
  Earnings before taxes

Author
Günther Kornfellner, CFA, CAIA 
Derivate Trader, Bybit EU