Price is what you pay. Value is what you receive. Warren Buffett’s famous quote perfectly captures the dilemma: when buying a business, one often feels one is paying more than it is truly worth. When selling one, the instinct is usually to think the price received is too low. In principle, supply and demand apply in a perfectly competitive market where very specific conditions are met. This may be the case for stock markets, which in theory satisfy those conditions when setting the share price of listed companies — in other words, their price. But how do you value a company that is not listed, or how can you verify whether the market price truly reflects a company’s value?
There are various methods used to determine the value of a company. None, however, can be described as an exact science, and the outcome of an appraisal produces as many values as there are methods. Among the most common, three stand out in summary:
Intrinsic value, which focuses on assets: it considers the actual value of everything the company owns, after deducting debts of all kinds. This essentially corresponds to the value of the equity invested, taking into account the profits and losses accumulated within the company.
Income value is based on the results the company is capable of generating. The company’s average profit is equated with the capital that would need to be invested at a given rate to produce a perpetual annuity of the same amount.
A third, more sophisticated method, known as cash flow discounting (in English discounted cash flow), takes into account the company’s future ability to generate liquidity to remunerate its financing, regardless of the nature of that financing.
These last two methods have in common that they measure the company by its performance. Modern approaches increasingly tend to favour the latter. After all, what is the real value of a company that is incapable of generating positive results?
They highlight that the entrepreneur whose aim is to maximise the value of the business must ensure its profitability in the short, medium and long term, rather than seek to increase its assets at any cost. In practice, this is the primary objective of managing a profit-driven business: to add value to the company.
Guidelines for adding value to your business
