It is good practice to know what your company is worth, to enable you to be prepared in the event of the unexpected passing of a business partner/shareholder or a potential business opportunity arising which could yield significant returns from the sale of the business.
The standard of value applied in a company valuation is that of fair market value. Fair market value is defined as the price at which an asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.
A widely used method within company valuations is the Discounted Cash Flow methodology “DCF”. The DCF approach assumes that the value of an asset can be determined by discounting the net cash flows that an asset is likely to generate during its remaining economic life back to its present value, using a fair rate of return, given the risks associated with the asset.
A common variant used in the DCF is that of a Free Cash Flow “FCF” variant. The cash flows derived by the FCF model represent the cash a business generates after accounting for cash outflows to support operations and maintain its capital assets. The FCF approach is a measure of profitability that excludes the non-cash expenses contained in the income statement and deducts cash outflows relating to the purchase of capital equipment used in the company, as well as changes in working capital. Interest payments are excluded from the projected cash flows.
The above method will enable a shareholder to determine a reasonable value of what the business actually is worth, given the current circumstances.