In the new economy, globalized and increasingly concentrated in fewer larger companies, those who earn the most are no longer the largest, but the fastest. A more profitable company is no longer the one with the largest size (more land, more buildings, more machinery, more image), but the companies that generate more cash flow for their owners. The value of a company then is not measured by its apparent size, nor by the value of its assets, but by its cash flow, and more specifically by its "free cash flow".
My specialty is finance, I have dedicated myself to that for almost 30 years. One of the most frequently asked questions is: " Enrique, from your point of view on how much you value my company." This is not a question that can be answered over coffee on a Friday afternoon, even with the latest financial statements for the business on the table. Financial statements are almost always unreliable, for many reasons. Entrepreneurs know which…
There are more than 18 methods to value a company. Some are simple and others are complex. Do not think that the most complex are the most effective. But some are so simple that one says "someone is winning here" and perhaps not the one who sells.
I have seen companies value their assets when their monthly profits are impressive and those who buy will be able to recover all their investment in less than four or five years, leaving the money in their accounts again and with very valuable properties. The seller believed that he sold "at the market price", of course the properties; But he lost a lot of money because his company was worth more than the properties he had.
I have seen a company sell five times the profit of a year. This method seems reasonable; but it assumes that the one who sells is going to pocket the “advanced” earnings of those sixty months and that the person who buys has to “wait” to start earning his share after the fifth year. That doesn't make sense.
What would you think if someone wanted to buy you a commercial premises building for the rents it produces in sixty months? Assume that the building produces $ 50,000 in rents, measuring 10,000 square meters. They would give you $ 3 million or $ 7.5 million. That valuation method doesn't make sense. Valuing a business is much more complete, with more reason the method is not reliable.
I have seen companies valued by sales, "multiplied by ten". Where did that idea come from? I do not understand. Sales will never reflect the profits of a business. One business can sell exactly the same as another; But both can have very different earnings. What's more, their cash flows could be even more different.
When an entrepreneur has many years of managing a type of business, he manages to develop an impressive ability to measure "the value" of a company. Using two or three criteria, he can quickly and easily set the price of a business he wants to buy, from the same line of business of years. I have witnessed this several times, with financiers in the middle and without a calculator, an entrepreneur asks for some information: square meters, location, volume of sales in units, etc., He does some calculations in the heading and says to the other "I buy you at $ 1 million dollars. ” In five minutes!. And the financiers and experts who were there waiting to collect their fees didn't earn a penny.
But it is not always possible to do it from ago; Because in many of these business purchases or sales, be they acquisitions or mergers, banks, investment funds, professional investors intervene. If they were two entrepreneurs who know about the business and sit down to "haggle" perhaps yes; but in today's world it is not always possible.
A few months ago an entrepreneur wanted to buy a business. Sellers were asking for $ 3.5 million and my client asked me for a "shallow" valuation. I asked for the information, they sent me some of very poor quality. I called him and said, “If you buy between $ 2 million and $ 2.5 million, you are buying at a good price. He said to me: "Okay Enrique, thanks, I offered $ 2 million." Where did you get the data, I have no idea? Sure, my friend knows the business line, he has years of doing the same thing, he has 14 stores, very profitable and he does it very well.
When a company does not list its shares, setting the company price requires somewhat elaborate financial techniques. They are not quantum science; But if a series of steps is required to establish a serious, reasonable and sustainable price. The first step is to have reliable, highly detailed and verifiable historical financial information. The second step is to have the ability to project the company for more than five years, to determine the expected results assuming the management and strategy that the entrepreneur has been bringing years ago. You cannot pretend to value a company for the value it will acquire if a new investor comes, injects capital, and takes the business to a higher level of growth.
The value of a company, assuming that it will continue in time, must be calculated based on its ability to generate cash, in our terms "free cash flow". The most appropriate method of valuing a company is to discount the expected future cash flows.
Before finishing, I want to say something that we all know in practice. The value of a good, ultimately, is determined by what a company is willing to pay for it. The same happens in business.
We also know from practice, and here the financiers are left over: any good, like any business, is worth more if they come to buy it than if I go out and offer it to the market. The law of supply and demand, pure and simple.
But if you want to sell a company, if you want to incorporate an investor to your business, if you want to look for capital abroad or simply want to know what is the estimated value of your company or your wealth today, you should use serious tools to measure that value.
