Valuation model for a business entity

Valuation model for a business entity is, obviously, the most complex. It is a financial valuation model and, therefore, is built around for corporate financial statements – income statement, balance sheet, statement of cash flows and statement of retained earnings. All worksheets (financial models are done almost exclusively in MS Excel) contain both historical information (3+ years prior) and forecasts (5+ years ahead).  

 In addition to financial value proper, which is always estimated, this model allows to calculate values of other financial KPI – free cash flow, ROIC, WACC and economic profit. 

You start building the corporate financial model with gathering and analyzing (1) macroeconomic data – inflation, exchange rates, etc.; and (2) data on your target markets. This information goes into your ‘input’ worksheets. Then you put together your historical financial statements.

After that, you have to make forecasts – of macroeconomic indicators, mostly. And of all other items that you have no control over. In other words, of your key external factors – political, social, cultural, legal, technological, environmental, industrial, etc. Of all areas where ‘we are not the makers; we are the takers’.

Which means that you must have someone on board who is real good at forecasting. Not fortune-telling; not clairvoyance – just good scientific forecasting. As development of a financial valuation model is an occupation that requires a lot of highly specialized knowledge and experience, you will most likely outsource it to a management consulting firm that specializing in advising on financial value maximization. These firms usually have good forecasters on staff.

All other items on your projected financial statements and other worksheets – revenues, expenses, assets, liabilities, etc. – are not forecasts. They are your plans. Your objectives. You targets that you plan to achieve to maximize your financial value. And, being your planned values, they must require the optimal degree of ‘stretch’. Seemingly impossible, but achievable all right.

There are theoretically several ways to calculate (estimate, actually) financial value of a business entity; however, in practice, virtually everyone is using the discounted cash flows (DCF) method. Other methods are used either to supplement the DCF method or for some very special situations.

This book is not a financial valuation guide; it is the guide for a comprehensive business analysis. Therefore, it can cover financial valuation issues only very briefly. However, financial valuation is an important enough topic for an in-depth study.

Hence, I strongly recommend that you invest a little of your money to buy, and the necessary amount of your time to study an excellent book by Tom Copeland, Tim Koller and Jack Murrin “Valuation: Measuring and Managing the Value of Companies” (now, I believe, already in the fifth edition or so).