The value of a commercial company is not static and varies over time based on its own performance as well as the prevailing business environment, both of which are dynamic in nature. A thorough understanding of the company, including its revenue streams, cost and value drivers, specifically in the context of the environment in which the company operates, is therefore extremely important. Business valuation is undertaken for a variety of reasons, chief amongst which are, raising funds from investors, monetising value, the exit of shareholder(s), settlement of disputes amongst shareholders and other such strategic reasons.
Key valuation methods
Whilst there are many methods of valuing a company, there are three key valuation methods that are used generally by investment bankers, equity research companies and private equities, and mergers and acquisitions specialists, etc. The method used may depend on the specific circumstances of the business and the availability of reliable information.
Using a combination of methods is likely to result in a more reliable and robust valuation. A brief overview of the key methods is summarised below.
Asset or Cost approach
This approach essentially considers the net asset value of a company, i.e., the difference between the total assets and total liabilities of a company. In simplified terms, the asset-based value is equivalent to the shareholders’ equity or the company’s book value. This method, which estimates the cost required to establish a similar business that will generate the same economic benefits for the company, is not used generally by finance professionals as it does not consider the value of the company on a going-concern basis.
This valuation approach is used to value companies which fulfil certain specific conditions such as – generating losses consistently, operating as a holding company with diverse investments, property/ investment funds or a non-operating entity.
Market or relative approach
Relative valuation, which is a market approach, is used to value companies by comparing them to other similar businesses in the relevant markets and is based on the presumption that similar assets should sell at similar prices. There are two types of relative valuations – comparable company analysis and precedent transaction analysis.
Comparable company or peer group analysis comprises reviewing current trading multiples like P/E, EV/ Revenue, EV/ EBITDA, Price/ Book value, amongst other ratios, to derive the value of a company and this method is frequently used by valuation professionals. On the other hand, precedent transaction analysis is a method of valuing companies based on historical transactions/ prices at which companies were sold or acquired. Whilst this method is a useful tool in M&A transactions, it is not reflective of prevalent prices and becomes less relevant with the passage of time.
The Discounted Cash Flow (DCF) is the most widely used income-method towards deriving the intrinsic value of a business and is based on the free cash flows generated by the company across the projected period, and to perpetuity.
Reviewing a set of financial projections involves a great deal of care to ensure that the projected numbers are realistic and achievable and are supported by sound underlying assumptions that are reasonable and appropriate for the purposes of the valuation. Such projections are used to derive the free cash flows of the business, which are then discounted to present value using a risk-adjusted discount rate or the weighted average cost of capital.
Another income method is the Capitalisation of Earnings Method, which is determined by dividing the future earnings by a capitalisation rate but this method is used more to confirm that values arrived at by using other methods are reasonable.
How can PKF UAE help?
Valuation of a company requires expertise at many levels, given the complexities in a company’s business, underlying macro and microeconomic factors, local dynamics and state of economy and sector specific information required.
PKF’s presence in the UAE since 1976, coupled with its experience with businesses in the country, sector-specific knowledge and technical capabilities in the valuation of companies in various business sectors enables it to value a variety of businesses. Values arrived at by PKF have withstood the scrutiny of peers and have formed the basis of many acquisitions, disposals, borrowing and lending transactions.
PKF’s valuation reports provide business owners with a view of the business and its value that allows them to make informed decisions. PKF adopts an appropriate approach and methodology depending on the specific circumstances of the company and the reason for the valuation, to arrive at a reliable range of values.
Contact PKF UAE for your business and share valuation requirements.