The health status of our company is one of the topics that interests us the most. By health status, we refer to the ability of our business to meet its fiscal and commercial obligations, etc., in addition to being able to provide the necessary resources to achieve stability and growth.
A good method to understand this health status is to value our company, that is, to carry out the process by which we will quantify the elements that constitute the current assets and the expectations of resource generation.
The valuation of the company will allow us to know the key data for making decisions or to initiate a negotiation, which can be for investment, new lines of business, and it also serves to convey to external agents the guarantees offered by the company, such as to potential investors interested in our business.
To value the company, we must exercise common sense accompanied by the necessary technical knowledge, so as not to lose sight of the relevant issues, which we can briefly summarize:
- The valuation is an estimate based on the company’s balance sheets, which does not guarantee the reliability of the data.
- The value of the company will serve to negotiate the price; it is not a forecast of the results of a negotiation, but the starting point.
- The value of the company is determined by its ability to generate income.
We must apply common sense not to confuse value and price; a company has different value for different buyers and for its seller, for example, depending on the prospects for the future of a particular sector, different strategies, possible economies of scale… We should not confuse it with the price, which is the amount that the seller and buyer agree to carry out the company’s purchase and sale operation.
The key factors for the process of valuing a company are:
- Cash flows: an investor is always concerned about recovering their money and the profitability it produces.
- Growth and potential: the greater they are, the greater value the company will have. Market size, position, innovation, expansion capacity.
- Financial history: if it has met its obligations, what has been its evolution, etc.
- Risks associated with the company: such as regulatory changes, operational and legal risks…
- Assets and liabilities: what elements form them and in what state they are.
There are multiple methods to value a company, each of them has its advantages and disadvantages, to choose one we must take into account the context and the sector to which our company belongs. Valuation methods can be classified as static and dynamic:
- Static methods: yield value, real assets, net worth, liquidation value.
- Dynamic methods: value based on discounted net cash flows, valuation by EBITDA multiples.
These are the most common, although there are many others that can be used for company valuation.
The most common errors when valuing a company are not correctly calculating the risk rate, making mistakes in the forecast of expected cash flows, not obtaining the correct residual value, not making a correct interpretation of the valuation…
In conclusion, through the company valuation procedure, we can obtain essential information for making strategic decisions or as a starting point to negotiate its sale or obtain financing from investors. There are many methods we can use; we must choose the optimal ones for our objective, avoiding errors that can lead us to an incorrect result of our company’s valuation.