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7. Cashflow Valuation
This method focuses on the cash that a business can generate. Unlike the DCF method, it doesn’t necessarily account for the time value of money. Instead, it may consider historical cash flow data to derive a valuation. This approach is often preferred for businesses with steady and predictable cash flows, like some mature industries or rental property businesses.
The ‘Cashflow Valuation’ method, in this context, incorporates financing terms, tangible asset values, and future cash flows to derive a comprehensive valuation of a business. It’s a method that can offer insights from both asset and earnings perspectives while integrating market-driven loan terms into the valuation process.
The table below provides an explanation and an example for each of the input variables related to the ‘Cashflow Valuation’ method:
|Tangible Asset Value||This represents the monetary value of the physical assets owned by the business. It excludes intangible assets like intellectual property, goodwill, or brand equity. This value can be a foundation for lending, as tangible assets can serve as collateral.||A manufacturing company has machinery, real estate, and inventory worth a total of £2 million. The tangible asset value would be £2 million.|
|Commercial Interest Rate and Loan Term for the Tangible Asset Value Calculation||These are the interest rate and loan duration terms provided by a lender against the tangible assets. This gives an idea of the financing terms a business could secure by using its tangible assets as collateral, helping in determining the value of such assets in the context of the overall valuation.||If a bank is willing to offer a 5-year loan against the tangible assets at an interest rate of 6%, the terms for the tangible asset value calculation would be: Commercial Interest Rate = 6%, Loan Term = 5 years.|
|Commercial Interest Rate and Loan Term for the Debt Value Calculation||These are the interest rate and loan duration terms provided by a lender considering the business’s existing debt structure. It provides an understanding of how the market views the risk profile of the company’s debt, which can influence the overall valuation.||A company with significant debt might get a quote from a lender at an interest rate of 8% for a 7-year term. The terms for the debt value calculation would be: Commercial Interest Rate = 8%, Loan Term = 7 years.|
|Commercial Interest Rate and Loan Term for the Cash Flow Valuation Calculation||The interest rate and loan term here are used to discount the projected cash flows of the business. Instead of using a typical discount rate like the WACC, this approach uses the terms of a hypothetical loan, giving a more market-driven perspective on the present value of future cash flows. This can provide a more realistic and practical view of the company’s worth.||If the market conditions suggest that a company’s future cash flows could be financed at a 7% interest rate for a 10-year term, the terms would be: Commercial Interest Rate = 7%, Loan Term = 10 years.|