The article Valuation Techniques by Nick Mansour and Alexander Tauber of Stanford University Graduate School of Business addresses the issue of accepted valuation techniques that can be used frequently by industry practitioners during a company evaluation. These techniques are necessary when buying, developing, and selling a progressing business. There are three methods of valuation covered by authors, namely:
- Balance sheet analysis
- Income statement valuations
- Discounted cash flows
Balance Sheet Valuations
According to the authors, balance sheet valuations are used to figure out the value of a business’s essential resources recorded in the bookkeeping explanations.
Three utilization of this method is generally involved when calculating:
- Book value
- Adjusting book value
- Liquidation value
Income Statement Valuations
The second method attempts to value an opportunity by capitalizing on its multiple earning streams. According to the article, a company is singled out, its ratio of value to earnings is calculated and applied to the last twelve months earnings to yield a valuation estimate.
Discounted Cash Flows
According to the authors, the third method states that a business value is equal to its future expected cash flows discounted at a rate that mirrors the riskiness of the cash flow stream. Steps to be followed to facilitate this valuation technique include:
- Projecting the Cash Flow Stream
- Choosing a Discount Rate
- Deriving a Terminal Value
- Discounting the Cash Flow Stream
Balance sheet techniques offer a quick starting point for the valuation process. However, they offer the least relevant valuation approximations. Income statement multiples are the most frequently used technique since it is easier in communication. Discounted cash flows can be used in a situation when the company does not have an operating history. Professional investors use two methods to value these opportunities:
- Comparables
- Required rates of return.