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What is a valuation?

Definition: Valuation is an analytical process of estimating an asset or business's overall worth and real market value

Valuation is done by the company itself or the potential buyer using objective measures such as a review of the company’s cash flow and comparison with other companies in the same industry. 

Other factors considered during valuation are market trends, historical data, current economic conditions, scarcity, and potential for future growth or decline.

The purpose of a valuation can be for financial reporting, taxation, estate planning, risk management, or facilitating a sale or acquisition. 

The result of a valuation is usually presented in a report or statement, and is used to guide decision-making and transactions involving the asset in question.

Valuation example and formula

Here is an example of a valuation of a SaaS company using the enterprise method to EBITDA multiple. The enterprise method is one of the most accurate measures of a company valuation because it includes non-stable capital structures. 

By dividing the enterprise value by EBITDA, we can get an accurate picture of the company’s value and determine if it’s undervalued or overvalued.

The formula:

EV/EBITDA= Market Capitalization + Debt+ Preferred shares - Cash/EBITDA

EV= enterprise value 

EBITDA = earnings before interest, taxes,depriciation, and amortization

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Article FAQs

What is the difference between a valuation model and a valuation method?
A valuation model is a framework determining how specific valuation methods will operate. For example, the discounted cash flow method falls under the absolute model.
How is valuation calculated?
By calculating and comparing the price-to-earnings ratio and the enterprise value-to-earnings ratio of similar public companies, we can calculate the valuation of the target company if we know the company’s net income.
What are the key elements of valuation?
The key elements of valuation are the company’s financial statements, position in the market, and competitive position.

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