Valuation stands for determining the value of an asset or a company. It is necessary for various reasons such as investment analysis, capital budgeting and financial reporting.
When it comes to the companies, there are multiple ways to define their value:
- Fair value is what a buyer is willing to pay a seller for it.
- Market value is a value of a stock or bond if the company trades on an exchange.
- Intrinsic value stands for the perceived value of a company based on future earnings or some other attribute that is unrelated to the company’s market price.
There are two main categories of valuation methods:
Absolute methods determine the intrinsic value of a company based on fundamentals such as dividends and cash flow. When using an absolute method, the analysts do not compare the company with other companies.
Relative methods compare the company with other companies. These involve, for example, calculating the price-to-earning (P/E) multiple and comparing it to the P/E of other similar companies. The relative methods are often easier and faster and many analysts start the valuation with these.
In the start-up world, the important concepts are pre-money valuation (without the external financing or the latest round of funding) and post-money valuation (with the external funds or the latest capital round). It is important to know which one is being referred to as the ownership percentages of a company can differ depending on the timing of valuation.