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Corporate finance and valuation are two interlocking business functions that use a company’s accounting information. The first part, corporate finance, applies formulas and principles to a company’s financial information. These formulas often help a company value its net worth or other business departments. Corporate finance and valuation typically provide stakeholders with three different methods for valuing a company. These methods include the asset, market and income approach to business valuation.
Under the asset valuation approach, corporate finance and valuation comes together to determine a company’s value for each owned asset. Owned assets represent physical items that a company uses in the normal course of business. These items have long-term value and often have a salvage value, meaning that the item will have some value even after it is considered useless for business operations. Corporate finance rules require companies to find a replacement cost for all assets owned. When summed together, the assets represent the company’s total asset value.
A market approach takes a bit more work when using corporate finance principles. Under this approach, a company can derive its value based on past sales, earnings or transactions from a similar company. Corporate finance and valuation techniques under this method might be a bit more difficult to use. The biggest problem with market approach valuation is that past success might not be indicative of future results. Additionally, corporate finance formulas might require the use of averages for certain figures, which can lead to distorted computations.
The third and final approach under corporate finance and valuation is the income approach. This method requires corporate finance techniques to convert a specific level of income to a multiple. Income approach valuation allows a company to extend the multiplier over a period of several months or years. This creates a system whereby stakeholders can create valuation reports that should be more reliable than using a market-based valuation approach. A distinct problem, however, is the ability to compute an incorrect conversion factor that again results in distorted figures.
While standard accounting information can provide data on a company’s period-to-period success, corporate finance transforms this information to proper valuation figures. Corporate finance and valuation methods can present figures either for internal valuation or when selling the business. For example, an owner who is looking to sell a business might use one of these techniques to determine the asking price. This presents verifiable information for an arm's-length transaction. In most cases, this is the main purpose for corporate finance and valuation formulas.