We give you 6 methods of company valuation

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In order to value a company properly, it is necessary to have some technical knowledge of, for example, company valuation methods, and sufficient experience in company sale and purchase transactions. It is very important to achieve a good result and to always keep in mind the objectives of the exercise, i.e. why and for whom the valuation is being done.

According to Pablo FernándezIn his book "Valuation of Companies", IESE professor, "the main valuation methods are diverse, but they can be classified as follows".

Main company valuation methods including discounted cash flow valuation

Discounted Cash Flows: one of the most widely accepted methods of company valuation.s

According to the IESE professor, the only conceptually correct method is the DFC. It is a valuation method based on projecting all future cash flows generated by the company's operations and discounting them by the return demanded by investors.

This method is the most widely used method in valuation practice because it is able to take into account all the variables that affect the value of the enterprise. From its investment policy, to its efficiency in sales and production processes, to the competitive intensity of its sector, etc. The DFC is a dynamic method, as it takes into account future expectations. Therefore, it will be necessary to make projections of the financial statements.

What is the point of all the other methods if they are not correct?

The multiples method of valuation is widely used in shareholder agreements that regulate the entry or exit of shareholders.

Although, according to Pablo Fernández, the rest of the methods are not conceptually correct, the reality is that they are widely used in practice. The main reason is that they are easier to apply. For example, in shareholder agreements that regulate the entry or exit of shareholders, it is common to find references to valuation by multiples because they reduce uncertainty for all parties and make it easier to avoid future disagreements.

In the case of the multiples method, which is very widespread because of its ease of application and comparability between companies, it represents major limitations. Firstly, it is difficult to find companies similar to the target company and secondly, the result presents a very wide and dispersed range of values.

Under what circumstances can other methods be used?

Liquidation value is mainly used when the company is logically not going to continue its activity.

The DFC is the most appropriate in the case of continuity of the company's activity, which is the usual and desirable situation. But in those circumstances where the end of the company's operations is envisaged, the most appropriate method is the liquidation value which results from the difference of the sale of assets minus the cancellation of debts including staff severance payments and liquidation expenses.

Another circumstance in which the DFC does not apply is in the case of start-ups. The main reasons are the high uncertainty in the projection of future flows and the different risk rate in each round. For this reason, the so-called Venture Capital Method. This method is based on agreeing a return for the investor rather than a price and establishing ownership transfer mechanisms based on compliance with the business plan.

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