What is valuation?
Business valuation, literally means to evaluate your business to see how much it is really worth. So before valuation you need to understand the concept of valuation.
First of all, there are two concepts of valuation:
1, pre-financing valuation
2, post-financing valuation
In order to make it easier for you to understand, an example:
Suppose that the pre-financing valuation of a company is $10 million, and the amount of financing is $2.5 million. 2.5 million compared to $12.5 million after the financing of the investor's share of equity ratio is 20%. This is the pre-financing valuation.
In the same case, we use the post-financing amount to calculate the company's post-financing valuation of 10 million, the investor contributed 2.5 million. This makes the pre-financing valuation of the company 7.5 million, the post-financing total 10 million, and the investor has a 25% stake.
The same valuation amount, under a different argument, the company could have lost 5% of its shares for nothing.
5 minutes to learn how businesses are valued!
What are the common valuation methods?
1, PE method, it is also known as the price-earnings ratio method, PE = company value / net profit. PE method is applicable:
1) those less cyclical, relatively stable earnings.
2) Mature companies or those with relatively stable levels of revenue and earnings. If for some very early stage businesses, which may not yet be generating profits, then they cannot be valued on a PE multiple.
2, PEG method, evolved on the basis of the PE method, is the ratio of price-earnings ratio and earnings growth rate, PEG = (market price per share / earnings per share) / (annual growth forecast per share). the biggest feature of the PEG valuation is to take growth into account. "G" is the compound growth rate of the enterprise in the next few years (usually more than 3 years) Therefore, the PEG valuation method, fully consider the future growth of the enterprise, that is, the future expectations of the enterprise. PE, on the other hand, pays more attention to the current profitability of the enterprise. scope of application of the PEG method:
1) Generally applicable to the earlier enterprises, because the growth of the early enterprises is relatively high, if we just calculate by PE, this valuation is not very accurate.
2) High-growth enterprises. For example, nowadays the Internet business, may start with a relatively small amount of business, when the business development to a certain extent, there will be an explosive growth. For this kind of business can use this PEG method for valuation.
3, PS method, that is, PS = company value / forecast sales;
PS method is now used relatively little, but a few years ago will be often used. Commonly used in previous years because of more investment in the e-commerce industry. For many early e-commerce companies, it is not profitable, it is difficult to predict the growth of its profits. What is more predictable then is sales revenue. So at one time, the industry often used the PS method as a standard for valuing the e-commerce industry. For the current e-commerce project, may still use such a method to estimate the value.
Of course there are some shortcomings in this method, because the PS method focuses mostly on sales growth. This leads to companies going out of their way to rush sales. In the process, there is often a lot of marketing costs, as well as service costs. Sometimes even spending $11 in fees for $10 in sales. So when using the PS method, it is also important to consider the company's ability to control costs.
What does it mean that all of the above are relative valuation methods? Because the valuation method does not have an absolute basis for calculation, but rather the current state of a market, or the same type of company, or the same type of investment activities as a reference value.
4, DCF method; absolute valuation method of a, but also more commonly used method, it is also known as the discounted cash method, it will be the business of the next 5-7 years of operation to make some assumptions, so as to figure out the next few years of revenue, costs, profits. Then all the cash flows are discounted based on the rate of return and other factors. As for the discounted result is the value of the business at this point in time.
It is a more comprehensive approach. He will forecast the future operating results of the enterprise, and then discount this result to estimate the value of the enterprise. Theoretically, it can be applied to any type of business because it is based on basic operating data to make an estimate of future business profit or financial income model. It will involve many assumptions, such as the number of future orders for the business, the number of customers, unit prices, and costs. These data future assumptions, often from the historical data of business operations.
The biggest advantage of the DCF method is that it basically covers the complete valuation model, making assumptions about every aspect of the business, and then making estimates. So theoretically, its framework is rigorous and the most scientific.
There are advantages and disadvantages, for the DCF method, it will take a lot of time, and secondly, the quality requirements for historical data are particularly high. If these details are not handled well, the DCF method will have some limitations. In addition DCF can be laced with a high degree of subjectivity when making a large number of assumptions.
For example, the number of orders for enterprises this year has increased by 20%, that next year will have a 25% increase in the number of good work; as for the 25% of the number itself is more subjective. In addition, the enterprise's current product gross margin of 40%, assuming that the enterprise will launch a series of new products, gross margin can reach 60%, even if the enterprise can use some reasons to explain it, but it is still subjective assumptions. On the other hand, the investor thinks it is reasonable or unreasonable, but it is also his own subjective judgment based on the information he has taken.
So as the enterprise side must understand the details of the enterprise, and even some financial, financial formulas, when the investment institutions according to the DCF method to make the valuation of the enterprise, the enterprise should first judge whether the valuation is reasonable, if it is not very reasonable enterprise can be on the growth rate, the future scale of production, etc., to raise questions and doubts. Then the enterprise may talk about a reasonable valuation.
Generally speaking, the relative valuation method is the absolute valuation method to confirm and supplement. Often the reality of the financing process, most of the relative valuation method to set the price of the enterprise. Because the absolute valuation method is a complex and long process. Secondly, for the investment is not concerned about the future cash flow of the enterprise, but the future exit, is not profitable.