Wednesday, 18 January 2012

Company Valuation Methods

Firm Vluation Methods:
There are a variety of approaches to valuing a firm and its equity. The two most popular approaches are discounted cash flow (DCF) methods and market earnings multiple based methods.

Discounted cash flow methods generally project future expected cash flows, discount the value of each of those flows to present value using a discount rate, and then take the sum of those discounted values to represent the total value of the firm or the total value of the equity. Free cash flow to the firm (FCFF) is used to arrive at a total firm value. Free cash flow to equity (FCFE) is used to just value the total equity in a firm.

Market earnings multiple methods typically project out a future adjusted earnings amount for the next 12 months, such as EBITDA (earnings before interest, taxes, depreciation, and amortization) or net income and then multiply that earnings estimate times a multiple which is within the range of what other similiar firms have sold for in recent transactions.

As one might expect, valuations can often become complex (the subject of the proper discount rate has spawned numerous books itself) and contentious issues, particularly when the ownership interest being valued represents a controlling stake or there is a less than liquid market for that interest.

Use of Financial Ratios:
Financial Ratios are used to measure financial performance against standards. Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). The most useful comparison when performing financial ratio analysis is trend analysis. Financil ratios are derived from the three financial statemtents; Balance Sheet, Income Statement and Statement of Cash Flows. Financial ratios are used in Flash Reports to measure and improve the financial performance of a company on a weekly basis.

There are five (5) major categories included in the financial ratios list are:
- Liquidity Ratios
- Activity Ratios
- Debt Ratios
- Profitability Ratios
- Market Ratios

Liquidity Ratios:
Liquidity ratios measure whether there will be enough cash to pay vendors and creditors of the company.

>>Current Ratio
>>Acid Test Ratio(Quick Ratio)

Activity Ratios:
Activity ratios measure how long it will take the company to turn assets into cash.

>>Daily Sales Outstanding(DSO)
>>Accounts Receivable Turnover

>>Daily Payable Outstanding
>>Accounts Payable Turnover
>>Inventory Days Outstanding
>>Inventory Turnover

Debt Ratios:
Debt ratios measure the ability of the company to pay its' long term debt.

>>Debt Ratio
>>Debt to Equity Ratio(D/E Ratio)
>>Long Term Debt to Total Asset Ratio
>>Times Interest Earned Ratio
>>Fixed Charge Coverage Ratio
>>Debt Service Coverage Ratio (DSCR)

Profitability Ratios:
The profitability ratios measure the profitability and efficiency in how the company deploys assets to generate a profit.

>>Gross Profit Margin
>>Operating Profit Margin Ratio

>>Net Profit Margin
>>Return on Equity Ratio(ROE Ratio)
>>Return on Investment Ratio (ROI Ratio)

Market Ratios:
The market ratios measure the comparative value of the company in the marketplace.

>>Price Earnings Ratio(P/E Ratio).
>>Earnings per Share(EPS).

>>Price to Book Value Ratio(PBV Ratio).
>>Price to Sales Ratio.

>>Price Earnings Growth Ratio(PEG Ratio).
>>Dividend Yield.

Source ---------> wikiCFO

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