Company Valuation: Direct and Indirect Methods Analysis

Direct and Indirect Methods for Company Valuation

In recent years, company acquisitions and mergers have significantly increased, making it crucial to find effective valuation methods. These methods provide insights into a company's true market value. The approach to valuation depends on the motives, objectives, and reasons behind the assessment. There are simple methods, which use a single endpoint, and composite methods, which combine several criteria. Composite methods include direct (Anglo-Saxon) and indirect (practical) approaches. These methods aim to determine a company's value by combining different criteria, often drawing from experience. They consider intangible assets, such as goodwill, which reflects the company's market appreciation, reliability, image, and customer base.

Indirect or Practical Method

Also known as the German method, this approach estimates a company's total value as the arithmetic mean of its substantial value and performance value.

Substantial Value

This is the real value of the assets, regardless of financing. It represents the net asset value at the current market price of all components involved in the operation. It is often used in combination with the performance value (VR). However, the inclusion of financial charges in VR can lead to results that deviate from reality.

Performance Value

This analyzes the ability of a company's assets to generate income. There are two assessment systems: one considers the company's profits, and the other considers the flow of income.

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If profits are used, the method enhances the company's ability to generate profits from all financing sources after paying debtors. However, it ignores the opportunity cost of investing in the company. If profits are constant and the company's life is unlimited, the performance value will be:

If receipts and payments are used, the method considers the company's availability at that time and future solvency and liquidity requirements. If the flows are constant and the company's life is unlimited, the performance value will be:

These methods have drawbacks due to the complexities of calculation, especially when considering different values for each exercise or a residual value for the company.

For the German method, the contribution of goodwill to the company's value is often considered half, as companies tend to avoid overvaluation.

The board may also determine the goodwill (FC) by: FC = VR-VS

resulting in:

Direct or Anglo-Saxon Method

This method assumes that the company's value (VG) equals its substantial value (VS) plus goodwill (FC). It considers the total benefit of the company, consisting of normal benefits and special benefits (suprabeneficio). VG = VS + FC

First, the VS is estimated. Then, the interest that a lump sum equal to VS would normally provide at a market rate is assessed. The difference between the profitability obtained and the normal profitability represents the suprabeneficio, which can be considered as the FC.