What is “Value”?

Before one can determine a company’s valuation, the term “value” should be defined. At its core, value breaks down to an assessment of two primary components: risk and return. Simply put, the greater the risk or lower the future returns associated with an asset, the lower its valuation.

Valuation is the practice of assessing the risks and returns of an asset or liability and translating those considerations into a monetary value. Most people perform valuations in everyday life. The decision to purchase the latest gadget involves an assessment of the product’s benefits (i.e., the return element for the equation) and the risks associated with the purchase. In this case, risk factors may comprise product reliability, the continuity of the manufacturer’s support for the device, or its build quality, among many other potential considerations. The quality of a brand name or the product’s reputation among other consumers may mitigate these risk factors. Assuming that the benefits outweigh the risk, the consumer may purchase the gadget at its retail price (i.e., value).

In valuing a business, the same concepts apply, just in a different form. The measurement of return shifts from functionality to expected economic benefits of the asset over time. Risk assessments center around the likelihood of achieving the expected returns, business continuity, default and liquidity risks, reliance on key members of management, and regulatory changes, among many other potential factors. Since every business is unique, risk factors can vary significantly in deciding on an appropriate value.

For a business, risk and return often correlate with one another. Typically, the higher the expected return from a company, the greater the risk assessment and vice versa. These factors can be visualized as the two sides of a scale offsetting each other to determine the value of an investment. In essence, the more you add to a company’s expected returns, the more likely you are to feel uncertain (i.e., risk) about the achievement of those returns. In this way, assessing risk and return is often a balancing act and a fair valuation will not be biased to one side or the other.

ValuAnalytics provides valuation analytics based on your financial metrics to support your internal financial reporting or corporate planning processes. Request our analytics or contact us to request a personalized consultation to discuss your valuation requirements.