It is very important for a company to identify what they are the key parameters that most influence its continuous value creationSince, logically, the importance of each factor will not be the same for each company or for each sector.
To know and understand the most determining keys to the economic value of a company, we must identify the most accurate valuation method and the most important variables in this method.
The valuation method
At present, the Discount Cash Flows (DFC) it is the most accurate and is considered essential in any valuation process. This method combines both internal and specific variables of each company (economic and financial structure and the profitability of its activity), as well as external factors of the sector and demand for its products and services that materialize in a business plan and forecasts of investments, financing and results in a time horizon of between 3 and 5 years.
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The value of said company is obtained by treasury estimate that it is capable of generating in the development of its activity according to a coherent and planned strategy. These cash flows that would be obtained in the future are financially discounted to determine their value at the present time.
The fundamental variables
According to the methodology described above, the main variables that generate value in a company are: profits and recurring liquidity obtained (indicator of profitability of investments made); and the balance between the company's own and other funds (financial indicator).
These value generators are common sense. A company that earns a higher profit for every euro invested in its business will be worth more than a similar company that makes less profit for every euro of capital invested. Similarly, a fast-growing company will be worth more than a slower-growing one, if both are getting the same return on invested capital and that return is high enough to satisfy investors.
The right questions
One might think that, once the company's projection had been made and its cash flows discounted at the weighted average cost of capital, the valuation process would have ended.
However, once the valuation of a business has been carried out, we must ask ourselves a multitude of questions in order to increase its value continuously. What is observed when comparing the future projection with the past returns? How is the projection compared to that of other companies in the sector? What are the economics of the business? What other important factors can increase or decrease the value of the company?
Strategic planning
In summary, growth and return on invested capitalo (relative to the weighted average cost of capital) are the key factors that generate the value of a company. To increase this value, the company must plan how to achieve one or more of the following objectives:
- 1. Invest additional capital that provide a return higher than that obtained with current capital.
- 2. Increase the growth rate of sales or reduce operating costs to increase profits and profitability of current capital.
- 3. Reduce the current cost of capital without reducing the profitability of the assets.
Keep reading:
- Valuation of a company: a mixture of technique and art
- Valuation: the best indicator of a company
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