Question

What are the primary differences among the CF valuation model, asset-based valuation model, and multiples valuation model?

Answer 1

The primary differences among the CF valuation model, asset-based valuation model, and multiples valuation model:

Business Valuation:

For any Business Combinations like Mergers, Joint Ventures, Amalgamations, etc or even finding the Sale value etc, a Business Valuation is an important requirement.

Valuation is a process used to estimate the economic value of the business. This valuation is considered as a base for the investors/companies to determine the price to effect a purchase or sale of a business.

While there are many methods in place for assessing the valuations, each of these methods have their limitedness and exhaustiveness interms of application for the respective requirements; Hence, the financial managers should choose the best suitable / required method to apply for their requirement – asset purchase/sale, business CF valuations, comparative choices of investments / Multiples valuation etc;

However, in many cases of valuations, more than one method is applied as this helps the finance managers to assess the valuation to the best possible accuracy; Also, this approach of application of multiple methods shall cover the factors of valuation in more holistic way.

Among the various methods, Future Earnings or the Present Value of Future cashflows method or Cash Flow valuation Model is widely used;

Cash Flow valuation Model : In this method, based on the past trend and current strength and capacity of the company, the future cash flows are projected. The cash flows shall cover in more comprehensive way interms of Operations, any salvage value of assets, Working Capital changes, major CAPEX etc; These projected cash flows are further discounted to the Present Value using a Discounting factor; This factor is generally the Weighted Average Cost of Capital (WACC) based on the current capital structure. Finally, using this present value of the cashflows, the Enterprise Value is computed. Post adjustments of any Debt items/Cash and Cash equivalents to this Enterprise value, the resultant shall be considered as Equity Value.

This approach generally covers all the factors of operations, Debt structure, cost of capital and future expectations based on the current strength. A vision can be envisaged in a holistic way and thus helpful for the finance managers;

Once the Enterprise Value is assessed, it can used for comparing with the Market Approach, Peer comparison, EBITDA multiple approach to determine the final price between the buyer and seller of the business, in valuation.

In a typical Business valuations, once the Enterprise Value is determined using the above method, Book value method is used to determine the strength based on the actual value as at date and is used as a comparison or base for any working capital or debt adjustments in the Share Purchase Agreements / Business Transfer Agreements. Similarly, the EBITDA multiples are assessed and Peer (market) comparison is done to have better understanding and command on the valuation and thus helps the finance managers in better negotiation of final Enterprise Value.

Asset Based Valuation Model: In this case, the valuation is done based on the individual valuation of the assets and liabilities of the company on a given date. The valuations are done by external valuers and in total net assets (assets less liabilities) are assessed. This method is generally done in case of Asset purchase, when the business is already with the buyer. Also, this method doesn’t count for any business projections or future capabilities of the business and its operations.

Multiples Valuation method: This method is a simple consideration of EBITDA multiple of the peer companies or the sector in which the company is. Using this factor of EBITDA multiple, the valuation of the business is assessed based on the EBITDA generating capacity of the business. To be simple, the value of the company is evaluated as a multiplication of EBITDA and the EBITDA multiple. This approach is followed to have a basic estimate of the Price / Valuation range of the business.

Basic differences are that the CF valuation method looks at the future performance based capabilities of the Business and considers all the risk factors in evaluation; Asset Based valuation looks at only the potential of the existing assets and liabilities/obligations; Multiples valuation can be considered as a basic valuation to estimate the valuation range of the business using EBITDA multiples of peer companies / sector etc and doesn’t not build the risk factors associated with the business.