In today’s dynamic and highly competitive business world, determining the value of a company is essential for investors and business owners in evaluating its performance and unlocking a true investment potential. In this article, let’s discuss how to calculate a company’s valuation, its importance and more.
What Is the Valuation of a Company?
The valuation of a company is the process of finding out the financial worth or fair value of the business. This process involves assessing both financial and non-financial factors that contribute to the business’s value. Determining a company’s fair value can be helpful for various purposes like financial reporting, investment-related decisions, strategy planning, fundraising, mergers and several other purposes.
Different Methods To Find a Company’s Valuation
There are various methods that are used to find out the valuation of a company. And picking the right method depends on factors like the nature of the business, the industry, the financial information that is available and most importantly the intent of the valuation. Here are a few most commonly used methods for a company’s valuation:
1. Market capitalisation
The common method to determine the value of a publicly listed company is through market capitalisation. The formula to determine the valuation through the market capitalisation is, Valuation = Share price * the Total number of shares.
Also Read more about “Types of Market Capitalisation”
2. Discounted Cash Flow (DCF)
Discounted Cash Flow is one of the widely used valuation methods. It estimates the present value of a company’s future cash flows. It first forecasts a company’s expected cash flows over a specific period and then discounts them back to their present value at an appropriate discount rate. This rate is the company’s cost of capital or the Weighted Average Cost of Capital (WACC). The use of discounted cash flow methods in finding the company’s valuation can help in determining the company’s capability to produce liquid assets, i.e., terminal cash flow. In simple terms, it helps in determining if the present value of the company, which is derived from the predicted future cash flows, is more than the current value. However, the accuracy of this predicted present value can be a challenge. As the growth forecast, discount rates depend on assumptions and may change later.
3. Asset-based valuation
This method uses the Net Asset Value (NAV) of a company to determine its value. NAV involves calculating the total value of a company’s assets (both tangible and intangible) and subtracting its liabilities. This is a commonly used approach for companies with tangible assets like manufacturing companies or real estate.
4. Enterprise value method This method considers different capital structures of a company like equity, debt and cash or cash equivalents. The formula to determine the valuation of a company using the enterprise value method is:
Valuation = Debt + Equity – Cash
Example of How To Calculate a Company’s Valuation Using enterprise value method
Let us take an example to determine a company’s valuation.
Assume ABC Ltd and XYZ Ltd have a major market share in the pharma industry. Let’s compare both companies’ valuations using the enterprise value method.
The market capitalisation of ABC Ltd is Rs. 1,000 crore, liabilities of Rs. 300 crore and cash or cash equivalents of Rs. 5 crore.
Therefore, its enterprise valuation = 1,000 + 300 – 5 = Rs. 1,295 crore.
The market capitalisation of XYZ Ltd is Rs. 1,500 crore, liabilities of Rs. 850 crore and cash or cash equivalents of Rs. 20 crore.
The enterprise valuation of XYZ Ltd = 1,500 + 850 – 20 = Rs. 2,325 crore.
This concludes that:
- • The enterprise value of XYZ Ltd is high than ABC Ltd.
- • The liabilities of XYZ Ltd are more. Therefore, the volatility and risk are also higher.
Importance of Calculating a Company’s Valuation
Determining the worth of a company is essential because of the following reasons:
- • For investors, a company’s valuation helps in investment decisions, i.e., as an investor, you can assess whether the current stock price of the company is an attractive investment opportunity. You can also know if a stock is overvalued, undervalued or fairly valued.
- • It helps in understanding the fair value of assets and liabilities of a company, which is useful for financial reporting.
- • If a business owner is looking for financing, lenders or venture capitalists, they would want to know the company’s value.
- • If you are a partner in a company and would want to determine the value of your share in a company.
Conclusion
Determining the company’s valuation can keep you away from unfairly valued stocks that can pose a risk of losing capital. To keep your investments safe in the market it is vital to understand a company which ultimately helps you understand your investment. And to start your investment journey in the stock market, it is important to open a Demat Account. Hence open a Demat Account for free on Angel One. Happy investing!
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FAQs
What is the valuation of a company?
The valuation of the company is the process of determining the fair value of the company or its stock.
What is the information required to calculate a company’s valuation?
As there are different methods to determine the value of a company, the information required depends on the method you choose. However, certain basic data about a company that can come in handy are,
- Profit and loss statements
- At least 5 years’ balance sheets
- At least 5 years’ corporate tax returns
- Data about assets, liabilities and inventory
- Revenue forecasts and financial projections for the current year
Which company has a high valuation in India?
In India, the top 5 companies with high valuations based on the market cap are, Reliance Industries, Tata Consultancy Services, HDFC Bank, ICICI Bank and Hindustan Unilever.
Do we have a company valuation calculator?
There are several online calculators that can help in determining the valuation of a company. But you can look into the company’s financial statements and use any of the methods given above to understand the value.
What is the company valuation formula?
As the company’s valuation is determined based on several methods, there is no one fixed formula. You can use different formulas according to the method you pick to calculate the value of a company.
