Valuing a business is a complex and crucial process, demanding knowledge of industry, market, finance, and the enterprise’s strategy. Valuation not only helps owners understand their company’s true value but also serves as a basis for executing transactions. In this article, we introduce some of the most common valuation methods today.

Why Accurate Business Valuation Matters?

Valuing a business is a crucial process in business operations, especially during transactions involving buying, selling, merging, partnering, or investing. Business valuation not only determines the actual value of a business but also forms the basis for strategic decision-making and optimizing business efficiency.

What is Business Valuation?

In concept, business valuation is the process of estimating a company’s value based on factors like assets, revenue, profit, growth potential, risks, and external factors such as market, industry, competition… There are two types of values commonly used in company valuation: market value and fair value.

Market value is the price a buyer is willing to pay for a business in a voluntary and public transaction. Fair value is the price agreed upon by both buyer and seller in a reasonable and unpressured transaction.

The Purpose of Business Valuation

Business valuation serves various purposes, depending on the requester and executor. Some common purposes include:

• Executing transactions related to buying, selling, merging, partnering, or investing in a business. Valuation methods help determine a fair price for both parties, facilitating negotiation and contract signing.
• Building business strategies and development. Business valuation helps identify a business’s strengths, weaknesses, opportunities, and challenges, enabling decisions aligned with the current situation and future aspirations.
• Conducting financial reports and taxes. Business valuation helps determine the reasonable value of assets, equity, liabilities, and other incomes of a business, accurately reflecting the financial status and business operations in financial reports and taxes.

Factors Impacting Business Value

The value of a business is not fixed but fluctuates over time and circumstances. Several factors can influence a business’s value, including:

• Internal factors: These are factors related to a business’s operations, such as assets, revenue, profit, costs, development potential, risks, management, culture, and personnel. Internal factors can be controlled and improved by business owners and leadership.
• External factors: These are factors related to a business’s operating environment, such as market, industry, competition, customers, suppliers, policies, regulations, economy, and society. External factors are often difficult for a business to control and predict.

6 Methods of Business Valuation

Currently, there are various methods for valuing businesses in Vietnam, depending on the goals, data sources, and industry of the enterprise.

Average Ratio Valuation Method

This method compares a company’s financial ratios with industry averages or similar companies. The steps are as follows:

• Select relevant financial ratios for the industry and business type.
• Search for similar or industry-related businesses to compare.
• Calculate the financial ratios of the selected businesses.
• Calculate industry or group average ratios.
• Multiply the average ratios by the company’s financial ratios to estimate the value.

Business Valuation Formula: Estimated value = Average ratio x Financial ratio

Example: Company A has a post-tax profit of 100 million dong, and the industry’s average P/E is 15. The estimated value of Company A is: 15 x 100 = 1500 million dong

Transaction-based Valuation Method

This valuation method also compares a company’s financial indicators with past transactions of similar or related businesses, such as purchases, mergers, consolidations, or stock issuances. The steps are as follows:

• Select suitable financial indicators for the industry and business type.
• Search for transactions related to similar or industry-related businesses in the past.
• Calculate the financial indicators of the selected transactions.
• Calculate average transaction indicators.
• Multiply the average indicators by the company’s financial indicators to estimate the value.

Calculation Formula: Estimated value = Average indicator x Financial indicator

Example: Company B has revenue of 200 million dong, and the industry’s average EV/Sales is 2. The estimated value of Company B is: 2 x 200 = 400 million dong

Asset-based Valuation Method

This method assumes that a business’s value equals the total value of its owned assets minus liabilities. The steps are as follows:

• Prepare the company’s balance sheet, recording assets and liabilities.
• Adjust the market value of assets and liabilities, if there are differences from the book value. For example, fixed assets may be depreciated, inventory may lose value…
• Calculate the net asset value (NAV) by subtracting total liabilities from total assets.
• Calculate enterprise value (EV) by adding NAV to surplus value or subtracting deficit value of the business.

Calculation Formula: EV = NAV + SV or EV = NAV – DV

Where: EV is Enterprise Value; NAV is Net Asset Value; SV is Surplus Value, and DV is Deficit Value.

Discounted Cash Flow Valuation Method

Discounted cash flow assumes that a business’s value equals the present value of its future free cash flows generated. The steps include:

• Forecast the company’s free cash flows for a certain period, often 5 or 10 years.
• Calculate the present value of free cash flows using an appropriate discount rate.
• Calculate the terminal value of the business, which is the present value of free cash flows after the forecast period.
• Calculate the business’s value by adding the present value of free cash flows and the terminal value.

Calculation Formula: EV = ∑(FCFt / (1 + WACC)^t) + TV / (1 + WACC)^n

Where:

• EV: Enterprise Value
• FCFt: Free Cash Flow in year t
• WACC: Weighted Average Cost of Capital
• TV: Terminal Value
• n: Forecast years

Dividend Discount Valuation Method

This method is suitable for companies with regular and stable dividend payments. The steps are as follows:

• Estimate current-year dividend (D0) and dividend growth rate (g) of the business.
• Determine the discount rate (k) of the business.
• Calculate the business’s value.
• Calculation Formula: Business Value = D0 * (1 + g) / (k – g)

Where:

• D0: Current-year Dividend
• g: Dividend Growth Rate
• k: Discount Rate

Discounted Free Cash Flow to Equity Valuation Method

This method applies to companies with unstable cash flows or those not distributing dividends. The steps for valuing a company using this method are as follows:

• Estimate FCFE for the current year and subsequent years.
• Determine the discount rate (k) of the business.
• Calculate the business’s value.
• Calculation Formula: Business Value = FCFE / k

Where:

• FCFE: Free Cash Flow to Equity
• k: Discount Rate.

Valuing a business is a complex process requiring knowledge, experience, and flexibility. Accurate valuation not only helps businesses create real value but also plays a crucial role in strategic decision-making and market presence. Hence, entities should research various business valuation methods and apply the most appropriate and effective ones.