When one party transfers Business or Shares to another, it becomes essential for both buyers and sellers to know the worth of moving that particular asset. The process to see the worth is nothing but "Valuation". It is a saying that "Price" is what you pay and "Value" is what you get.
"Value" here refers to the worth of an Asset, whereas its "Price" is the result of a bargain/negotiation process between a willing but not an overeager buyer & seller.
Valuation is the method of arriving at the value of a company or an asset. Valuation is an art and not an exact science. The buyer thinks whether the product is "worth the price" he has paid; this "worth" itself is the product's value. Depending on the transaction structure, management may want to value the entire business segment or a business component - such as a brand, division, distribution network, etc. In addition, the importance of intangible assets such as patents, brands, human resources, intellectual property rights, etc., is increasing, and its valuation is also becoming a more common phenomenon.
Some of the instances for which we need a valuation are listed below:
It is essential to understand the purpose of the valuation before the commencement of any valuation exercise. The transaction structure also plays a vital role in determining the value/worth. The 'general purpose' value may have to be modified for the particular purpose of the valuation. The factors affecting that value concerning the specific intent must be judged and brought into the final assessment in a reasonable & sound manner.
There are few methodologies that a valuer may use/consider to value the shares of a Company / Business. Though different values arrive under various methods, a valuer must arrive at a fair deal. In practice, the valuer commonly uses several valuation methodologies and comes at a reasonable price for the entire business.
As mentioned earlier, the selection of appropriate valuation methods also depends on the purpose of valuation. For example, if the valuation is for liquidation, the valuer would want to fetch the Realisable Value of the Company's Net Assets and not its Earnings Capacity since the Company cease to exist, and the shareholders will be getting with the Net Assets.
Similarly, during a Merger, the valuer would want to value the companies involved again to arrive at a relative value. Following are generally accepted methodologies for valuation of shares/business: