What is a valuation? Definition and meaning
A valuation is an estimate of how much a business, property, antique or any asset is worth. If you have a business and seek funding from investors, they will need to know how much your enterprise is worth. This is achieved through a valuation – an estimate of the your company’s overall worth.
Many different techniques may be used to determine something’s value. An expert who is making a valuation of a company will look at its management, its capital structure, the market value of its assets, and its outlook (prospect of future earnings).
In the world of business and finance, items that are typically valued are financial assets, such as stocks, options, commercial enterprises, patents, or trademarks. Valuations may also be carried out on liabilities, such as the bonds issued by a company.
When carrying out a valuation of a business, there are several possible approaches:
1. The ‘Asset Approach’ looks at the company’s balance sheet and focuses on assets and liabilities.
2. The ‘Earning Valuation Approach’ looks at the economic benefits of owning the company – will the company be able to produce wealth in the future?
3. The ‘Market Approach’ focuses on the competition. How much are similar companies going for?
Valuations are required for several reasons, including merger and acquisition transactions, in litigation, investment analyses, financial reporting, and capital budgeting.
Reasons for a business valuation
There are many reasons why somebody may decide to have a business valued:
- to improve the business’ real or perceived value
- to choose a good time to buy or sell the commercial enterprise
- to negotiate a better price – either as a seller or buyer
- to complete the purchase of the business more rapidly
- to raise equity capital
- to create an internal market for shares
- to motivate management – regular valuations can provide a measurement and inventive for management performance and help management to focus on important issues.
A company’s value is mainly decided on multiples of its annual post-tax profit. A small unquoted business is generally worth, as far as potential buyers are concerned, between five and ten times its annual post-tax profit. Some IT businesses have been sold for considerably more, sometimes up to seventy times their annual net profit.
When a potential buyer is valuing a company, he or she may also make an entry cost valuation. Rather than purchase a business, how much would it cost to create a similar company from scratch? The estimated amount is the entry cost valuation.
The worth of a company depends on how much profit a buyer can make from it, balanced by the perceived risks involved. Past profitability and current asset values are only some of the factors that are taken into account. Often, the intangible factors such as intellectual property and goodwill provide the most value.
Regarding a valuation of your business, Canada Business Network, part of the Canadian Government, makes the following comment:
“There is a saying in the venture capital industry: ‘The value of a business is only what someone is willing to pay for it.’ In other words, the market, and your ability to attract investors and negotiate with them will determine the value or selling price.”
“Remember that many factors affect the value of your business. Seeking professional assistance can help you calculate an accurate value for your business.”
The most common valuation the majority of people need to have carried out is for a property they want to buy or sell. It benefits both the seller and the buyer.
Most buyers will request a valuation either because their lending institution insisted on one, or because they want to make sure that what they are buying is really worth the asking price.
Most mortgage lenders insist on a valuation as part of the home loan application process. The lender needs to ensure that the security value of the property covers the loan amount.
If anything happens and the borrower is unable to pay the mortgage repayment installments, the lender – usually a bank – needs to be confident that it can cover the money owed by re-selling the property.
Most lenders use their own nominated panel or preferred licensed property valuers.
A property valuation is normally produced as a report, and includes property information – the size of the land and building, rates, details on the construction, the condition of the property, and information on any immediate issues that may need to be addressed – as well as information on comparative sales in the immediate area.
The valuer visits the property, measures it, notes details on its condition and structure, makes notes on the property’s vehicle access and any garages or carports, lists any structural faults, and describes what improvements need to be done.
The valuation usually includes photographs of the property, highlighting specific features. The valuer also looks at planning restrictions, and compares all its attributes with those of comparable properties before coming up with an estimated value.
Mortgage lenders will not approve a loan if no property valuation is carried out. The lender needs to make sure the property is worth at least as much as the loan, so that if the borrower defaults, it will get its money back by selling the house.