Dr. John Psarouthakis, Founder and former CEO, JPIndusries,Inc., a Fortune 500 industrial corporation. Publisher of www.BusinessThinker.com
Before you can begin final negotiations on price, you need to determine the value of the company. You can use several techniques to value a company. We recommend the discounted cash flow value approach as the most accurate method although other approaches are useful in preliminary stages of your search to give you a sense of the range of the estimated price.
Timing and Scope of the Valuation Process
An initial calculation of valuation can be done on a fairly mechanical basis, based on information provided to you by the seller using established formulae and guidelines. However, determining the accuracy of the financial data that the seller provides you is an on-going part of the evaluation process that should take place throughout preliminary and formal due diligence up to the closing. Thus valuation takes place along with negotiations throughout the deal-making process. One of the key objectives of due diligence is to surface any information that might affect the accurate valuation of the company. If your team does not have a financial auditor you should hire one to verify the accuracy of the historical data.
Once you verify the completeness and accuracy of existing documents, historical valuation of a company is often relatively easy from a technical standpoint. But it may be a fairly inaccurate reflection of what you can expect from the firm’s financial performance in the future. Thus, although a preliminary valuation of the company might be done initially when you first receive financial data from the company, refining the financial assumptions about the company’s future performance must take into consideration a wide array of non-financial considerations. Accurate forecasting requires a thorough understanding of general trends as well, trends specific to your industry, the economy, and of course a thorough understanding of the strengths and weaknesses of the particular company you plan to purchase.