3 Ways in which the valuation of a firm is done
Corporate finance deals with the decisions that business organizations make and also with the tools that they employ to make these decisions. The primary aim of corporate finance is maximizing corporate value while managing the firm’s financial risks. It increases the value of the firm to its shareholders. You, as a manager of an organization, should keep in mind that corporate finance studies the corporations alone, unlike managerial finance that studies all firms. However, the main concepts of corporate finance are applicable to the problems of all firms.
Corporate finance deals with the strategic financial issues associated with maximizing corporate value. The concerns of capital finance are, what investments the firm should make, how to raise the capital, what part of the profit should be given to shareholders as dividends.
All these decisions that are made by the managers and are the core of corporate finance are made following various ways. Some of the ways are as follows.
1.Valuation by using balance sheet: Managers can make better decisions if they can predict well how a particular decision will affect the value of the firm. This can be done by observing the difference in the firm’s equity value at different points of time. One way of valuing the equity of a firm is by subtracting liabilities from assets from the company’s balance sheet. However, it must be remembered that this method is very easy but not very accurate. This is because some assets may be recorded as historical costs. Their present value could be much higher or much lower than what is shown in the balance sheet. Moreover some assets such as loyal customers, patents, trade marks and talented managers do not appear on the balance sheet but influence the future profits of the company.
2.Cash and profits: You could also consider the flow of cash that will take place in future. This is important as cash today is worth more than that same amount of cash tomorrow. You must have a valuation model that can discount the value of cash that is received in the coming years. This will be able to give you an accurate picture of the true impact of financial decisions. You must realize that all decisions that you take affect the operations. The working capital of the firm flows in a circular form. The cash that you put into the business in the beginning is converted into equipment and raw materials. The extra cash that you posses is used to convert these into inventory. Inventory is then converted into accounts receivable and this is then converted into cash. The goal that corporate finance has is that there should be more cash at the end of the cycle than at the beginning.
3.The sources and the usage of cash: It is really important to know where the cash comes from and where it goes. There are two sources of cash they are- reducing your assets or reducing your liabilities. These factors should be considered to evaluate the financial state of the company.
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