Business Valuation

Business valuation is an important process when buying or selling a company. It helps the buyer or the seller to get the accurate value of the business before making a commitment. Therefore, the evaluation process is a critical aspect of determining the best estimate value for the business in a world where acquisitions and mergers are inevitable. However, the Bible commands that the process should articulate ethical and moral values and principles to ensure it is fair and transparent. In Leviticus 19:13, the Bible commands that it is wrong to impress your neighbor or rob him; therefore, each party should receive benefits that are equivalent to the value-generating capacity of the business. There are numerous benefits of conducting honest and fair business as not only does it foster trust, but also enhances the brand equity. In this context, a good reputation precedes the monetary gains of the business valuation process.

Discussion

A growing number of entrepreneurs and business owners are unaware of or underestimate the benefits of an articulate business valuation process. It is a common scenario in the business environment because the valuation is a complex multi-step process that utilizes different approaches. Nevertheless, irrespective of the valuation method selected, it simply involves a comprehensive evaluation of the current value-generating elements of the business to ascertain its financial viability (Reilly & Schweihs, 2013). In addition, the competitive position of the business within its operating industry sector, as well as its future financial expectations, are also evaluated. Therefore, the type of business evaluation selected is dependent on factors specific to the operating industry sector, expected cash flow, the size of the company as well as the type of service or product the company offers to its consumers. Irrespective of these factors, the goal of a business valuation process is to highlight the key value-generating aspects of the business. However, it is noteworthy that the business valuation process is intrinsically technical; therefore, it should be conducted by competent professionals.

The primary objective of the business valuation process is to highlight the key value-generating areas of the business. Hence, the method utilized should highlight the specific value or interest for each party involved in the valuation process (Trugman, 2017). For instance, depending on the objectives of the mindset of the investor, making higher returns on investment may not be the primary objective as they may desire strategic positioning or to grow the market share. The evaluation process is, therefore, considered an estimation of a value range that is dependent on the business interests of the parties involved. Some of the factors to consider include profitability, personal reasons, the validity of the available information, and the operating environment of the business (Fazzini, 2018).

Business Valuation Factors

Profitability is one of the common consideration during the evaluation process as a business can either make a profit or loss. A comprehensive risk analysis of the business is, therefore, essential to ascertain the investment status of the business. Psalms 112:5 commends conducting business in a fair and just manner as transparency ensures justice. It is also worth noting that investors are also people affected by emotions and feelings besides the economic factors of making a business decision (Fazzini, 2018). For example, a seller who is interested in selling a business venture fast as possible will prioritize time over fair value. In this context, the time constraint is a factor that influences their decision-making process. Thus, understanding the personal motives of the seller is essential to bottom-line reasoning for both parties in the transaction. Such a scenario presents the buyer with an opportunity to take advantage of the limited time the seller has to undervalue the business. While this opportunity may make economic sense, it contradicts the teachings of Proverbs 22:16 on oppressing the poor and the weak to increase personal wealth. Jeremiah 22:13 also warns against building a house/business by unrighteous and unjust means. Therefore, the buyer in this context has an ethical and moral responsibility of ensuring the seller receives appropriate compensation for their business irrespective of the personal factors affecting their decision-making process. It may not be the ideal economic outcome based on the circumstances, but it is the best outcome for both parties.

Proper valuation of a business venture should be informed by valid information. Gathering relevant and valuable information is a prerequisite before considering a business valuation exercise. Historical data is essential in this context as it helps to make accurate and correct future value predictions (Trugman, 2017). Only with valid information coupled with a reliable estimation method, is it possible to make accurate conclusions. Therefore, efforts should be made to obtain comprehensive and detailed information about the company’s past and present to understand the value proposition of its business operations. Proverbs 21:5 advises entrepreneurs and business owners to make diligent plans as they only can lead to abundance. Diligent plans are only possible if a person has detailed and comprehensive information about the business operations (Reilly & Schweihs, 2013).

Lastly, it is important to understand the operating environment of the business as external factors and market forces influence business operations. For instance, the company will be worth more independent of its intrinsic value when the market trades at high volumes as compared to when the market has cooled down. The stock market in this context presents an investment alternative for the investor. The majority of investors will always invest in business opportunities that offer the highest returns on investment for the smallest amount invested. If an investor has an opportunity of investing in a small business venture whose value is double that of a large-sized firm, the investor will most certainly select the former option. The size of the business venture will become a second priority to the value generated by the operations of the small business venture.

Business Valuation Approaches

            Although there are numerous methods of conducting business valuation depending on the objective of the evaluation, there are two main approaches used by analysts to achieve this objective. The first approach is the discounted free cash flow method, which focuses on determining the ability of the company to generate wealth by estimating the total amount the owners of the business are likely to take home during its lifespan (Reilly & Schweihs, 2013). The objective is to convert future cash flows using the “discounted rate” in today’s currency to reflect the future valuation of the company. The assessment also includes the potential risk that is associated with the process of generating the approximated wealth. Essentially, this business valuation approach provides important insights about the future performance of the business and its ability to create wealth using the available company resources. This approach to business valuation is supported by Proverbs 14:15, which emphasizes the need to critically think and evaluate future plans and commitments. Using the discounted free cash flow business valuation approach thus helps to provide invaluable insights into which business factors contributed to the generated revenues and incurred expenditures. Besides the factors that have influenced the past performance of the business, this approach helps to pay attention to factors that may influence future financial projections (Reilly & Schweihs, 2013). This approach also allows for competitive positioning analysis and market analysis to be taken into consideration when estimating the value of the business. Porter’s five forces model can be used in this context to evaluate the threat of substitute, barriers to entry, negotiation power of the suppliers, negotiation power of buyers, and rivalry of competitors. The insights gained enable the buyer to anticipate changes in demand, understand the company’s availability due to abundance of substitute products, and inform the measures to use when negotiating with suppliers and clients.

            The comparable transactions approach is the other method of business valuation that is widely used. It is simpler, faster and more practical even though it might prove to be far from reality if it is not performed correctly (Trugman, 2017). Since this business valuation method is based on assumptions, there is a possibility that it can lead to future discrepancies between the buyer and the seller. The discrepancy is attributed to the seller’s approach of estimating the value of the business on the next value generation as opposed to the existing value. This could lead to a breakdown in negotiations because the buyer and the seller might have different valuation expectations. In most cases, the buyer is interested in the current value of the business rather than the next value generation of the business, which most sellers prefer to ensure they gain in case the business increases its value in the future (Trugman, 2017). Moreover, wrong business valuation estimates are common in cases where comparisons are made with companies whose profits are lower than 50%. The comparative variables become insignificant due to the vast difference between the sizes and the valuation of both companies. For this reason, the discounted cash flow method is the most preferred method of business valuation because it is more accurate.

Conclusion

            The business valuation process should ensure that the outcome is mutually acceptable by both parties. All the opportunities may present to take advantage of the circumstances of the seller; it is ethically and morally wrong to gain from the misery of the weak and the poor. In addition, due diligence utilizing comprehensive and detailed company information should be conducted to ensure accurate and correct estimation of the key value-generating aspects of the business. The discounted free cash flow method of business valuation provides better estimates than the comparable transaction method because the former is based on valid company information, while the latter utilizes assumptions.

References

Fazzini, M. (2018). Business valuation: theory and practice. Cham, Switzerland: Palgrave Macmillan.

Reilly, R. F., & Schweihs, R. P. (2013). Guide to intangible asset valuation. New York: American Institute of Certified Public Accountants, Inc.

Trugman, G. R. (2017). Understanding business valuation: a practical guide to valuing small to medium-sized businesses. New York: American Institute of Certified Public Accountants.