Question

Explain the process of evaluating an existing business.

Answer 1

STEP 1: Determining a company's net worth

The first step is to estimate the net worth of the business. Basically, this step deducts liabilities from tangible and intangible assets (e.g. goodwill).
(ii) STEP 2: Company's past earnings
The next step is to determine the past earnings of the business. It is expected that if a business has been performing well, it will usually continue to perform accordingly. The business annual earning (past year) is multiplied by a rating of the business performance. Lambing and Kuehl (2007) outlined that the usual ratings range from 5 to 10. The ratings are estimated based on the company track record. If the business is doing well with established market, less intense competition, loyal customers, popular product and so forth, the ratings would be generally higher.

(iii) STEP 3: Company's discounted future earnings
The future earnings of the business is calculated using the discount factor.
(iv) STEP 4: Value of the business
The value of the business is determined by summing up the above three values. Weights are estimated depending on the importance assigned on those values. For example, in an industry which undergoes dynamic changes, past earnings will be assigned smaller weightage as it may no longer be accurate in predicting the future.

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