Financial Planning & Analysis and Performance Management

22BUSINESS VALUATION AND VALUE DRIVERS

CHAPTER INTRODUCTION

Nearly all valuation techniques are based on estimating the cash flows that an asset, for example real estate or a firm, can generate in the future. Two critical points are worth emphasizing. First, the value of any asset should be based on the expected cash flows the owner can realize by holding that asset or selling it to another party. Second, only the future expectations of cash flows are relevant in determining value. Historical performance and track records are important inputs in estimating future cash flows, but “the market prices forward” based on expectations of future performance.

It is important to recognize that valuation is both an art and a science. While we outline a number of quantitative, objective approaches to valuing a business, many other nonquantitative and perhaps even irrational factors do affect the value of the firm, especially in the short term. It is a marvel that each day millions of shares of stock are traded on the public exchanges, with buyers and sellers on both sides of the transaction, one deciding to sell at the same value at which the other has decided to purchase.

Commonly used valuation techniques fall into two major categories: (1) estimating the value by discounting future cash flows, and (2) estimating the value by comparing to the value of other similar businesses. This chapter is not intended to be an exhaustive work on business valuation; that has been the objective of ...