How to Calculate Company Valuation

What is a Business Valuation?

A business valuation gauges the economic value of a company. They are used in a number of situations, including when entrepreneurs want to determine the sale value of their business, when raising a round of financing, for tax purposes, and more.

When seeking financing from lenders, investors or venture capitalists, businesses may need an ABV-certified professional to carry out your company valuation. This certification is awarded by the American Institute of Certified Public Accountants (AICPA) after passing an exam. However, if you are simply looking to understand how much your company is worth, you can proceed with your own analysis by using one of the methods below.

How to Calculate Company Valuation

There are many approaches when it comes to company valuations, but we will focus on the three common ones in this article. Each one comes with distinct benefits as well as downsides, so it is recommended that business owners evaluate which is best for their particular situation.

Book value

This approach is fairly straightforward: Business operators value their company by using information found on the business’ balance sheet. This approach simply calculates the difference between company assets and liabilities. Let’s say you have $300,000 in assets and $60,000 in liabilities, the value of your company is $240,000. After this step, intangible assets also need to be excluded. Although this is the fastest and easiest way to calculate company valuation, it doesn’t paint the most accurate picture of a business’ true value.

Discounted Cash Flow (DCF)

This valuation method is based on adjusted future cash flow projections, which estimates the current market value of the company - and the attractiveness of an investment opportunity. This method also takes inflation into consideration to calculate the current value of the business.

There are four steps to this process.

1. Determine the time period of the investment

2. Determine the projected annual cash flow

3. Select a discount rate (or interest rate)

4. Find the terminal or final value after the calculation is completed

The formula for DCF is:

DCF Example:

When a company analyzes whether it should invest in a project, it often uses the weighted average cost of capital, also known as WACC, as the discount rate to evaluate the DCF. You can learn how to calculate the WACC of your company here.

Let’s say your company’s WACC is 5%, then this will also be your discount rate. Now, the initial investment is $6 million, and the project will run for 4 years, with the following estimated cash flows each year:

Now, we will use the formula to determine the discounted cash flow:

Lastly, we will add all the discounted cash flow results together, which comes out to $8,605,570.  By subtracting the initial investment of $6 million from this value, we get a net present value (NPV) of $2,605,570.

If the terminal value determined by the DCF analysis is greater than the cost of the investment, then the opportunity may be a good one with a positive projected return. This may help you better understand the value of your business and potential interest from investors to put money into your business.

You can also use valuation modeling in Excel. Valuation modeling refers to the forecasting and analysis using several different financial models. It includes discounted cash flow (DCF) analysis, precedent comparables, and comparable trading multiples. These financial models may be developed from the ground up in Excel or developed using existing templates.

EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization)

Using the EBITDA method is one of the most common ways to measure the financial health of a business. Calculating company valuation using the EBITDA method removes external accounting factors and non-operating expenses and focuses on the business’ operating performance.

EBITDA is often utilized because it helps measure operating profitability of a company. It lets investors assess corporate profitability net of expenses and is a snapshot of the business’ net income before interest payments, taxes or the depreciation of assets.

The result of this is a clearer picture on the operational performance of the company. It is calculated by adding interest, tax, depreciation and amortization expenses to net income.

In order to calculate EBITDA, you need to get a hold of your income statement where you’ll find tax and interest figures. Next, find the depreciation and amortization figures on your cash flow statement.

There are two EBITDA formulas you can use, one focused on net income and the other on operating income:

EBITDA Example:

Let’s say your company generates $50 million in revenue, incurs $10 million in overhead expenses and $20 million in COGS (cost of goods sold.) Depreciation & Amortization expenses come out to $5 million, with an operating profit of $15 million.

Your interest expense is $2.5 million leaving earnings before taxes of $12.5 million. With a 20% tax rate, net income equals $10 million after subtracting $2.5 million in taxes.

When adding back depreciation, amortization, interest and taxes to net income, EBITDA equals $20,000,000.

This figure represents your company’s net income before other factors listed above. After this step, you can then divide this number by revenue to produce the EBITDA margin, which is a ratio that indicates the business’ operating profitability. As a rule of thumb, the higher the margin, usually 10% or higher, the better the company looks to investors.

The Bottom Line

Whether you are looking to sell your business or simply just want to gain a better understanding of its current value, a company valuation is a helpful way to gain clarity about your business. There are many ways business operators can calculate business value for their firm, and when done correctly, opportunities and threats can become clearer. You can also avoid bidding wars when trying to sell your business and know when to walk away with an accurate business valuation.

Stay tuned for our second installment of this series, where we will discuss how to increase company valuation when looking to sell your venture.