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12 The value of a business > Methods of valuing a business - Pg. 171

ThE vAlUE oF A bUSInESS 171 So far in this book we have discussed ways of measuring and improving performance. These are all essential to business success and value creation but so also are relationships and collaborative manage- ment of the value chain. Methods of valuing a business The economic value of a business is used by buyers and sellers to determine the price they are prepared to buy or sell a business for. It is necessary for all mergers and acquisitions. A business valuation is also used for estate, taxation and a number of other legal purposes. Before a valuation can be undertaken it is necessary to understand the reasons for the valuation. For example, a valuation of a ship for scrap will be different from its valuation as a cargo carrier. A value will take account of the price that a willing buyer and a will- ing seller will agree to. This is called the fair market value (FMV). The market conditions may, however, be far from perfect. For this reason a business valuation will usually start with a contextual evaluation of the economic and industry conditions surrounding the business. Is it a buoyant market or is it in recession? An analysis of the business's financial performance and strength will be compared to the rest of the industry. The valuations placed on competitors will be taken into account. Common approaches to an initial business valuation are: income/earnings valuations as a going concern; asset valuations as a going concern; break up asset valuations; market valuations as a going concern. Each of the above approaches will relate to a particular reason for selling or buying. Often a business will be valued on several bases and the dif- ferences between the valuations explained. Before deciding upon which is the most appropriate valuation method the reason for a valuation will be considered. Possible reasons include: The valuation of a company to compare with the offer price of a takeover bid. These can also be compared with the current share price.