Valuation methods for enterprises

What is the enterprise value?

The enterprise value is the estimated market value of a company at a specific point in time. This is determined with the help of a company valuation. This considers not only tangible assets such as land and machinery, but also intangible assets such as the expertise of the employees or the brand. Other factors include individual aspects such as industry and regional differences.

Enterprise value vs. company price

The enterprise value and the price at which a company is to be sold should be distinguished from each other. While the value can be determined, the price is the result of individual negotiations. No price can be determined without a value. And the price can deviate from the estimated value and therefore be higher or lower.

Valuation methods for companies

In principle, the value of a company can be determined in various ways: Among others with the following:

• Net asset value method
• Future earnings value methods, such as the capitalized earnings value method or the discounted cash flow method
• Comparison/multiplier methods, such as EBIT multiple

Net asset value method

In the net asset value method, the company substance is valued as a reproduction value or liquidation value.  This is based on the tangible assets, including real estate, machinery and raw materials, less existing liabilities. Because this method only determines the liquidation value of a company, in practice it is only suitable for determining a base value. When using the net asset value method, the future value of a company is not considered.

Capitalized earnings value method

The determination of the company value using the capitalized earnings value method is aimed at the future revenue surpluses and thus the future income that a company will generate. The capitalized earnings value of a company is the sum of all financial and non-financial benefits. It is therefore based on forecasts of future cash flows. The company value is determined in 4 steps:

• correction of the past operating result for extraordinary and one-off expenses
• determination of the profit to be expected in the future
• determination of the capitalization interest rate
• determination of the final capitalized earnings value

The advantages of the capitalized earnings method include the fact that it is recognized in theory and practice as fulfilling the principles of the decision value and that the valuation of the company as a whole corresponds to the principle of the valuation unit.

The disadvantage is that the forecast of future profits is purely subjective and could be problematic in the case of strategically motivated acquisitions.

Discounted cash flow method

The discounted cash flow method (DCF method) is a widely used, recognized method for company valuation both nationally and internationally. Like the capitalized earnings value method, it is a future success value method. The DCF method is a classic instrument of value-oriented corporate management, the principle of which is to determine the value of a company by discounting future cash flows.

The advantages of the DCF method include the fact that cash flows are less likely to be distorted by accounting policy measures and that a detailed forward-looking calculation is used as the basis. In addition, company-specific risks and the principle of subjectivity are considered in company valuations.

The disadvantage is that the valuation is based on budgeted figures and therefore depends on the accuracy of the planning calculation and that the company can only be depicted approximately. In the case of growth-oriented companies, it is also difficult to check plausibility due to the lack of historical data.

Multiplier method

In the multiples method, the company value is determined using the market prices of listed companies or industry multiples (e.g. FINANCE Magazine). The multiples represent the ratio of various key figures from the profit and loss account (e.g. EBITDA, EBIT, etc.).

The multiples method is very frequently used in valuation practice. However, when valuing small and medium-sized companies, there is often no information on similar transactions or companies. The multiples from external sources are therefore only approximate values.

The advantage of this method is, on the one hand, the objectivity of the valuation approach, as it is based on historical capital market data. Secondly, the data is easy to obtain and use.

Disadvantages include the identification of comparable companies and the focus on the past. Furthermore, there are difficulties with negative earnings figures and the time at which the multiples are determined.

Tips for choosing the right valuation method

There are no general recommendations for a specific valuation method. The choice of the optimal method is always an individual decision that depends on various factors, including the type of company, industry and available data. Companies should therefore not fixate on a single method. Studies by renowned analysts on the frequency with which certain methods are used in valuation practice have shown that an average of 2.65 valuation methods are used per valuation case. A mix of individual methods is therefore often a smart solution.

Conclusion

Enterprise valuation is a complex process that requires careful analysis. There are various methods to choose from. One of the biggest challenges is choosing the best method, which ideally requires professional advice. A well-founded valuation is essential, as this is the only way to make the right decisions.

Do you need support with the sale of your sole proprietorship?

We at Conpair AG are happy to help you with the valuation of your company. We have many years of experience and know exactly what is important. We also have a broad network of experts at our disposal. We are also at your side during the negotiations. The sale of a company is also an emotional challenge. We maintain an overview and ensure that the transaction runs smoothly.