In this section we have collected financial definitions for words and terms related to business valuation. Hopefully some of these terms will help you along the way in your different valuation approaches. Some of these terms deserves a longer explanation than is there today, if you want to submit a better and more extensive explanation, please email it at info(a)ourdomain.net.
In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset.
Capital Expenditure (CAPEX), funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment.
Capitalization rate (or “cap rate”) is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value.
Capital asset pricing model
In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset’s non-diversifiable risk.
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities.
Cash flow refers to the movement of cash into or out of a business, a project, or a financial product. It is usually measured during a specified, finite period of time.
Cost of capital
In business and finance, the cost of capital is the cost of obtaining funds for, or, conversely, the required return necessary to meet its cost of financing a capital budgeting project. Said another way, it is “the minimum return that a company should make on its own investments, to earn the cash flow out of which investors can be paid their return.
A balance sheet account that represents the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of business. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash.
Discounted cash flow (DCF)
In finance, the discounted cash flow (DCF) approach describes a method of valuing a project, company, or asset using the concepts of the time value of money.
Earnings Before Interest and Tax (EBIT).
Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA.)
Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents. Think of enterprise value as the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company’s debt, but would pocket its cash.
The expected return is the weighted-average outcome in gambling, probability theory, economics or finance. It is the average of a probability distribution of possible returns, calculated.
Fair Market Value – FMV
FMV is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the real estate market.
Financial statements (or financial reports) are formal records of the financial activities of a business, person, or other entity.
Fiscal year (FY). E.g. FY3 = is future fiscal year three. If today is 2009, FY3 is 2012. The abbreviation is often used when estimating future values.
Initial public offering
An initial public stock offering (IPO) referred to simply as an “offering” or “flotation,” is when a company issues common stock or shares to the public for the first time.
Latest Fiscal Interim (LFI) (For a US-listed company, this is typically the latest quarter; but for a non-US company, this might be a semi-annual or trimester period instead)
In finance, liquidity risk is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit).
Latest Fiscal Year (LFY).
Latest Twelve Month (LTM) (typically calculated by taking the sum of last four quarters or last two half years).
Market based valuation
Market based valuation is a form of stock valuation that refers to market indicators, also called “extrinsic” criteria (i.e., not related to economic fundamentals and account data, which are “intrinsic” criteria).
The total dollar market value of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company’s shares outstanding by the current market price of one share.
Market risk is the risk that the value of an investment will decrease due to moves in market factors.
Net present value
Net present value (NPV) or net present worth (NPW) is defined as the total present value (PV) of a time series of cash flows. It is a standard method for using the time value of money to appraise long-term projects.
A publicly-traded company is a company that has permission to offer its registered securities (stock, bonds, etc.) for sale to the general public, typically through a stock exchange, or occasionally a company whose stock is traded over the counter (OTC) via market makers who use non-exchange quotation services.
Rate of return
In finance, rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested.
Risk-free interest rate
The risk-free interest rate is the interest rate that it is assumed can be obtained by investing in financial instruments with no default risk.
A risk premium is the minimum difference a person requires to be willing to take an uncertain bet, between the expected value of the bet and the certain value that he is indifferent to.
An account shown in the current liabilities portion of a company’s balance sheet. This account is comprised of any debt incurred by a company that is due within one year. The debt in this account is usually made up of short-term bank loans taken out by a company.
Weighted Average Cost of Capital – WACC
WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere.