CORPORATE The value of a company: How to choose the right valuation method!

Choosing the proper valuation method for a company is often challenging, as different methods can lead to different results. Many managers of medium-sized companies ask themselves which method best reflects the actual value of their company. The solution lies in selecting a valuation method that best suits your company’s specific circumstances. The capitalized earnings value method is particularly suitable if the focus is on future earnings potential. The discounted cash flow (DCF) method provides a detailed assessment by considering the time value of money. The multiples method can be helpful if there are comparable companies in your sector that you can use as a guide.

Capitalized Earnings

The capitalized earnings value is one of the most common methods for valuing medium-sized companies. It is based on the assumption that a company’s value is determined by its future earnings. The focus is on the company’s ability to generate sustainable profits.

• Calculation approach: First, the company’s future earnings are forecast. These forecasts are then discounted to the valuation date to determine the present value. The present value of the expected earnings represents the capitalized earnings value of the company.
• Advantages: The method is helpful for companies that generate stable and reliable profits. It considers the individual earnings situation and thus adapts well to the company’s circumstances.
• Disadvantages: One disadvantage is that the method is heavily dependent on the assumptions and forecasts made. Incorrect estimates can lead to a considerable misjudgment of the company’s value.

Discounted cash flow (DCF method)

The discounted cash flow (DCF) method is a refined method of valuing earnings. It is often used for larger or more capital-intensive companies. It is based on the discounting of future free cash flows to determine the company’s value.

• Calculation approach: First, the company’s future cash flows are estimated over a certain period of time. These cash flows are then discounted to the current date using a discount rate that reflects the cost of capital and the company’s risk. The sum of these discounted cash flows gives the enterprise value.
• Advantages: The DCF method is very detailed and provides a thorough analysis, considering both the operating profit and the capital structure. It is particularly useful for companies with highly volatile earnings or those where capital expenditures and depreciation play an important role.
• Disadvantages: The method is complex and requires extensive and precise data. Small changes in assumptions, such as the discount rate, can significantly impact the calculated company value.

Multiplier method

The multiple method, also known as the comparative value method, compares the company to be valued with similar companies in the industry. A multiplier based on key figures such as sales, EBITDA (earnings before interest, taxes, depreciation, and amortization), or profit is used.

• Calculation approach: The enterprise value is determined by multiplying a company’s financial indicator (e.g., turnover, EBITDA) by a multiplier that is customary in the industry. This multiplier is usually obtained by analyzing comparable transactions or listed companies in the same industry.
• Advantages: Based on existing market information, the method is simple and quick to implement. It is particularly suitable for sectors with many comparable companies and established market standards.
• Disadvantages: The multiplier method can only be accurate if there are comparable companies or if the industry is subject to strong fluctuations. In addition, it often needs to consider the company’s specific characteristics, such as innovation potential or company-specific risks.

Why is it so important to analyze financial data accurately?

An inaccurate or incomplete analysis of financial data can lead to an incorrect company valuation. This effect could deter potential buyers or investors or lead to an inappropriately low sale price. A precise and comprehensive analysis of the financial data is crucial. This analysis includes accurately recording turnover, profit, cash flow, and equity ratio and a realistic assessment of future economic development.

What is the challenge in valuing intangible assets?

Intangible assets such as brand image, employee know-how, or customer relationships are difficult to quantify but significantly impact the company’s value. Many managing directors need to pay more attention to this aspect. It is important to take intangible values into account in the valuation process. You can call in specialist consultants to help you quantify the value of these factors. It may be worth taking a closer look at aspects such as your market position, innovative strength, or the loyalty of your customers and including them in the valuation.

What role do external consultants play in company valuation?

Without external advice, there is a risk that the company’s valuation will be influenced by internal bias. Another disadvantage is that internal resources may not be sufficient to cover all aspects of the valuation. External consultants bring not only expertise but also valuable experience from similar transactions. They can bring an objective perspective, uncover weaknesses, and identify optimization potential that will increase the company’s value. A good advisor will guide you through the entire valuation process and ensure that all relevant factors are taken into account.

How do market and industry factors influence the company valuation?

External market and industry factors can significantly impact a company’s value. Changes in the market or competitive situation, for example, can cause the value of your company to rise or fall. A thorough market and industry analysis is essential. You should closely monitor current trends and developments in your industry and analyze how they affect your company.

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