It is a general rule for valuers, that a valuation should be made for a company when considering the latter as a whole, on the basis of all the information that can ensure the reliability, neutrality, clarity and transparency of the valuation itself.

It should be stated, firstly, that the valuation of a company is never a mechanical application of criteria and formulae.

To conduct a credible valuation, aside from a series of conceptual instruments and information, one has to have the capacity to “understand” the company, its policies and its strategies.

And one has to know how to view the company within the system in which it operates.

Therefore, the valuation is and will always be supplemented by a knowledge of the management, the effectiveness with which it is run and the improvements that can be made, as well as the medium/long-term outlook in terms of growth and capacity to achieve and control the growth. Moreover, it is evidently important to have knowledge of the macroeconomic situations, and an ability to predict them, for the country/countries in which the company operates; in addition to the characteristics of the sector it belongs to.

In fact, there is a certain grounding in the statement by a part of the economic-business theory that in certain countries the “general” conditions influence the value more than the conduct of the companies themselves, as they are significantly affected by these conditions.

As has been said, the value of company cannot be established only by applying mathematical formulae and relevant parameters.

A company is a “complex” entity, which is hard to express only in terms of formulae, as useful as these might be.

Valuing a company means taking into consideration elements, information, considerations, etc. that cannot always be expressed in a numerical form. The value judgment of a company is of a qualitative-quantitative type because it is also based on the subjectivity and relativity of the valuer.

Apparently, the reason for which the valuation is carried out appears to be irrelevant.

However, it influences the choice of the value in a crucial manner.

If the function of the valuation is the request for a bank overdraft or a guarantee, the valuation will be expressed with a value that is very close to the liquidation value, because the degree of debt collectability is considered.

If, however, the function of the valuation is the request for insurance coverage, the value will be expressed in market terms.

The value of the company is therefore a “relative” figure which is not unique, not unambiguous, it is not defined, but is rather valid at the date on which it is expressed and under precise conditions. There is a margin of subjectivity in the valuation, which is due to the human intervention of the expert. It is a fact that this occurs regularly in practice, even though it is not justifiable from a theoretical perspective.

The very choice of a method produces a final result that is different from that produced with another method, because assumptions are different, because the elements it considers are not identical, because the formula exclusively values certain aspects.

The criteria used to value companies are extremely varied: some are based on historic data in Financial Statements, that are documented and corrected to “normalise” and supplement them, where necessary, with market values.

They therefore obtain valuations based on the equity value (accounting net equity, corrected with values from certain Financial Statement entries) or on the income values (resulting from the capitalization of the normalised net income).

The value of the company that is thus obtained is the “theoretical” value, as it is quantified irrespectively of the effects resulting from its setting within the market context, but it may becoming “virtual”, as the price that is paid in the actual transactions can also be significantly different from that calculated using theoretical-traditional valuation methods.

The empirical methods

The empirical methods, which are often used in professional practice, as also confirms by Gianmauro Sherman Nigretti represent a series of rules of experience inspired by the market and based on widespread opinions existing in the sector in which the company being estimated operates.

The empirical methods do not represent rational valuation rules, that are methodologically and theoretically recognised, but they are normal criteria – despite not being completely accurate – in various concrete situations.

These company valuation criteria are often used in the professional practice, and they are not theoretical models, but simple mathematical relationships that link company factors and variables. They are in fact “rules” based on experience and the observation of certain analogies (or differences) in value.

In most cases, these are highly valuations based on a single parameter that is representative of the entire company (e.g. the number of customers who on an average day use a restaurant).

To obtain a safety margin that is sufficient for applying empirical methodologies, we need to refer to parameters and prices used in the latest operations or negotiations, so that these are systematic and significant.

The conditions of applicability of empirical methods are the following:

-quality of the source of information;

-reliability of the source of information;

-how significant the information is;

-representativeness of the negotiation volumes.

The empirical criteria are based on considerations and observations that are repeated over time (examination and valuation of historic series of referred data, e.g. prices and quantities sold).

The empirical criteria include, for example, the value of the authorisation (for commercial companies that operate as retailers, where the authorisation is obligatory) and the customer factor.

Frequent cases of application are:

-value of the funds (banks);

-value of the premiums portfolio (insurance companies);

-value of the authorisation (retailers);

-value of the publications (publishing companies);

-number and value of the customers and the length of time they have used the company (commercial companies);

-number and value of products sold (in the case of commercial companies of products with a single high value).

Empirical methods base on rules of thumb I

– do not represent rational valuation rules (that are recognised by the theory) but they are widespread criteria in practice (they are essentially a rough estimate of a company);

– in the majority of cases, these are valuations based on one or more parameters that are representative of the entire company.

Empirical methods base on rules of thumb II

– to obtain a better result, reference must be made to similar companies, operating in the same sector and to parameters and prices used in the last operations/transactions or negotiations (as long as these are relevant, reliable and significant);

– have a clear “popular” connotation, are extremely simple to apply, involve limited (or non-existent) costs, overcome the problem of the reliability of accounts.

Examples

The value of a chemist is equal to twice the average annual turnover plus the supplies; the value of a company that operates in the sector of insurance brokerage is worth the unitary price of a clearing house (established in recent transactions) by the number of houses reduced by a deduction coefficient given by the average employment rate (between 50% and 75%).

Valuing a company

The question of how to value a business is one which pops up frequently on Accountingweb. In truth, a business is only worth what someone will pay for it : the price paid on the day of sale is the only time that a company value is not a matter of opinion or conjecture.

It is useful to meet two or three experienced accountants, professional advisors and brokers to guide you on the value of the company. It is at this point a decision must be made on whether to use an intermediary to sell the company or to go it alone.