Discussion on Valuation Techniques for entrepreneur

A significant skill that an entrepreneur must have is the ability to evaluate. Valuations are said as an art, rather than a science. The valuation techniques are focused on specific parts of the business namely, balance sheet, income statement and discounted cash flows. The valuations that are done using the balance sheet attempt to find the worth of assets that are used in the business. Valuations by balance sheet gives three types of values i.e; the book value, the adjusted book value, and the liquidation value. Then comes the income statement valuation technique, it makes an attempt to value an opportunity by capitalization of its earnings streams. This valuation uses three steps, find a company whose enterprise value is known, and earnings in the same industry as a target. Calculate the ratio of value to earnings for that entity. The last step is the application of this ratio to the earnings of the last twelve months results of the target opportunity. This is how a valuation estimate will be gained. The DCF technique says that the value of any business is equal to the expected future cash flows that are discounted at a rate that shows the riskiness of the cash flow streams. Four steps are followed in this technique of valuation, the first one is the establishing the streams of cash flows, in the second step a discount rate is chosen, third is the determination of a terminal or ending value for the business. In the fourth step the chosen discount rate is applied to the projected streams of cash flows. These three techniques of valuations derive different results for the same business opportunity and give varying estimates. Each of these techniques is used in different circumstances and has its own advantages and drawbacks. It is upon the discretion of the user to use it accordingly.

Company Valuation Techniques in M&A

In an interview with the leading practitioners it was found out how major investment banks use DCF Technique in merger and acquisitions. The volume of M&A has exceeded from $12 trillion in the US alone in the past decade. It was revealed that DCF method was used as a routine measure in M&A valuations by leading practitioners. Another revelation was that, DCF techniques are only used for information purposes and they do not serve the purpose of decision making. This study is divided into 3 parts, the first part comprises the approach and sample, discussion of key findings is in the second part and third part gives the conclusion. The discounted cash flow method was routinely used by firms in benchmarking the investments. WACC is based on individual sources and it tells the investors the required returns based on the opportunity cost for investing somewhere else. Three challenges were highlighted the first being the determination of the terminal value, this was sorted out by replacing all the cash flows that were arisen after a chosen date by a terminal value. The second being that a single company has a range of businesses and divisions, now businesses can either focus on a part or whole of the business. The third challenge was that acquisitions may be affected by changes that are occurring in the business. It was concluded that firslty the DCF framework was in the routine use of firms for the purpose of valuations. Secondly, banks make estimations of discount rates based on alternatives that can be availed in financial markets. Thirdly, the application of DCF techniques requires judgment in the business forecasts that are uncertain inherently. Fourth is that banks think whether they can use the sum of parts valuation for companies that have multiple businesses. Fifth, that the valuation of synergies is a challenge in M&A due to the uncertain nature of synergies. Finally we can say that, DCF gives information not decisions.