The Business Valuation Process Step by Step

The Business Valuation Process is probably the most important part of Value Investing. Before taking the investment decision, we have to analyze in dept all the characteristics of the company and its environment in order to understand its business and forecast its future performance. Once we finish the analysis, we will be able to value the company in an accurate way.

The Business Valuation Process is more complex than the valuation of other kinds of assets. For example, if we are valuing a real estate investment, we don’t have to take into account aspects such as accountancy or business strategy, which are fundamental in the case of business valuation.

In this article, I am going to try to highlight the most important steps of the Business Valuation Process. These steps are 4: Business Strategy Analysis, Accounting Analysis, Financial Analysis and Prospective Analysis.

I want to clarify that these are only the main steps of the Business Valuation Process, and that each step is complex and takes time. Hence, this article can be used as a guideline to new value investors want to carry out their first analysis step by step. I will explain each of each step more profoundly in further articles.

First Step – Business Strategy Analysis

The main objective of Business Strategy Analysis is to identify key profit drivers and business risks in order to assess company’s profit potential at a qualitative level.

This step is fundamental because it enables us to frame the subsequent accounting and financial analyses. For example, the accountant and financial analysis will not be the same for a biotech company and a utility company.

Second Step – Accounting Analysis

The objective of Accounting Analysis is to evaluate the degree to which a firm’s accountancy captures the underlying business reality. We are analyzing the adequacy of the accounting methodology used by the company.

An appropriate accounting analysis improves the reliability of conclusions from Financial Analysis (the next step in the valuation process). Accounting Analysis could warn us about companies with suspect accountancy such as Enron, which hided its huge losses using different kinds of accountancy tricks.

Third Step – Financial Analysis

The main goal of Financial Analysis is to use financial data in order to evaluate the current and past performance of a firm and to assess its future sustainability. There are two important characteristics related to the Financial Analysis: It should be systematic and efficient and it should allow the analyst to use financial data to explore business issues.

The two most commonly used financial tools for this kind of analysis are Ratio Analysis and Cash Flow Analysis. Ratios Analysis is used to assess product market performance and the financial policies of the company. Cash flow analysis is used to measure the liquidity and financial flexibility of the company.

Fourth Step – Prospective Analysis

This step focuses on forecasting a firm’s future. In this step we have to take into account all the conclusions taken from the three previous steps in order to make prediction about the future performance of the firm.

Prospective analysis depends considerably on the future business scenario. We have to take into account possible facts, such as mergers & acquisitions or the possibility of bankruptcy. As it is impossible to predict the future in an accurate way, we can make different scenarios and give different probabilities to each of them in order to obtain the final intrinsic value of the company.

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