As with everything in life, there are certain advantages and disadvantages to some of the most widely used business valuation methods.
The market is more active every day and, basically, forces companies to understand how to generate value within their respective market segments, beyond what they sell or their profitability. By applying these business valuation methodsIn this way, it is possible to know where the company is and how much value it has generated.
There are currently a number of different business valuation methodsbut the most successful is the discounted cash flow method, because it ensures a much more accurate calculation (although for some strange reason very few company valuation "experts" use it).
However, we will also detail here the other methods for a valuation of companies:
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- Internal rate of return method
- Settlement value method
- Valuation method by multiples in the market.
Each of these methods has a different way of being used, and brings a different functionality to each company. In the following, we will show this in more detail, along with the advantages and disadvantages of these methods. methods of company valuation.
Advantages and disadvantages of the discounted cash flow method
First, the discounted cash flow method is by far the most reliable to be able to carry out a valorization of companiesbecause it guarantees a precise and accurate calculation, limiting any risk of error.
The structure of the discounted cash flow method is based on the following mathematical formula:
However, in spite of being an infallible method, widely used and the best in terms of the valorization of companiesis not exempt from having its advantages and disadvantages.
Advantages of the discounted cash flow method
It is the most widely used. Perhaps for many this is not a very good advantage, but it really is. Because it is such a widely used method, it directly means that it is the best as far as the valuation of companies.
Adds value to the company. Thanks to this company valuation methodThe value in growth opportunities, the cost of capital and the time value of money (long term) can be obtained.
Disadvantages of the discounted cash flow method
It is based on an uncertain future. One of the great disadvantages of this type of system is that it company valuation method is that the future is uncertain, which makes it necessary to make assumptions about future events in order to determine the outcome. Although there is no precise method that can know what will happen in the future, this method at least tries to come close.
Ignores other relevant aspects. This method only focuses on cash flows, hence its name. It ignores other elements that may be important such as liabilities, historical information of the company, intangibles, among others.
Advantages and disadvantages of the internal rate of return method
This practice is similar to the cash flow method discounted for the valorization of companiesThe main difference is that it will be calculated with an internal rate of return: the well-known IRR. Here it will be compared with the discount rate and will show whether it is profitable or not for the company.
This method is not the most widely used for the valuation of companies, but it is used to compare the level of profitability of different projects owned by the company. The formula for this method is as follows:
Advantages of the internal rate of return method
It allows to know the profitability. Thanks to the mathematical calculation of this formula, it is possible to know how profitable a company is.
Creates value for the company. Like the discounted cash flow methodThis method makes it possible to determine the value of companiesThis allows us to know how much value it currently has.
Disadvantages of the internal rate of return method
It does not incorporate negative cash flows. The main disadvantage of this method is that it does not allow the incorporation of periods with a negative flow, so it cannot be used.
It does not provide a full valuation of companies. This method only evaluates whether or not an investment is feasible at a given rate, so it is not directly focused on a specific investment. valuation of companies.
Advantages and disadvantages of the valuation by multiples approach
This company valuation method is another of the most widely used, but it is the least accurate for exact precision. It is based on the results of transactions or valuations obtained by the company.
Advantages of valuation by multiples
It is measurable through transactions. By relying solely on the level of transactions, this method makes it possible to determine the value of the company based on the level of value obtained by the transactions.
Disadvantages of valuation by multiples
It only evaluates the operational situation. This method is only focused on determining the current state of the company's operational situation, omitting everything else it incorporates.
Advantages and disadvantages of the liquidation value method
This company valuation method will be based on the financial and accounting identity, so the value of the fixed assets and everything related to the liquidation process will be obtained. Basically, it determines how much the assets are worth when liquidated.
Advantages of valuation by multiples
It is a concrete method. Since the value information can be obtained through the assets by liquidation, this method allows to know how much they cost or what value they contribute to the company.
Disadvantages of valuation by multiples
It only evaluates at a specific time for the company. The main disadvantage of this method is that it will only evaluate at a certain point in time, otherwise its value may be lost over time (long term).
Where to go for a business valuation?
Thanks to the valoriza.comyou can always get the peace of mind you need when you get a valorization of companies subject to precise calculations.
We invite you to contact us so that we can provide you with more help and information about business valuation.
