Calculating the fair market value of a Private Company can be a complex assignment; nevertheless, it is an important financial skill to understand. One needs to understand that the process of calculating the worth of a company is assessing the total economic value of a business. During calculation, all aspects of the business are evaluated to determine the company's current worth. The valuation process is important for many reasons, such as determining sale value, investment, tax reporting, etc.
Methods of Private Company Valuation
1. Book Value:- This is one of the most straightforward methods of valuing a Private Company. Under this method, the net worth of the private company can be valued by using the information from its balance sheet. You simply subtract the private company’s outstanding liabilities from the company’s assets. However, you must include the value of intangible assets in this calculation (example- Intellectual Property owned by the company). The balance sheet can also give you a fair idea about the private company's net assets for that financial year.
2. Discounted Cash Flows:- This method involves calculating the Discounted Cash flow it is expected to generate in the future. It calculates the present value of future cash flows based on the discount rate and time period of analysis. One of the benefits of calculating this factor is that it reflects a private company’s potential to generate cash in the future. However, this can be complicated since the assumptions that one makes about the future growth of the private company may not be accurate.
3. Enterprise value:- Under this method of valuation, the value of an enterprise is calculated. This is done by combining the private company’s debt and equity and removing the amount of cash it is holding in the bank at that point. To put it in the equation, it will be as follows:-
Enterprise Value = Debt + Equity – Cash
Earnings Before Interest and Taxes:- This method calculates the ‘Operating Earnings’ of the Business. Operating earnings is essential to be calculated since it shows the true income of the private company- after deduction of interest payments to debt holders and tax policies. Knowing the true income of the private company is important because it helps in the calculation of the total net assets of the company, along with the net value of the stock price.
One can use these methods in order to know the net value of a company. People tend to research the true value of a private company before they can either invest or sell the company, which is the right thing to do. The valuation of a Private Company involves a lot of facets. It is because of this reason that taking expert’s opinion before making any significant moves is always advisable, in order to get your money’s worth.