Meaning
Mathematical models calculate the worth of a company or its shares based on sets of financial variables. Valuation formulas provide a consistent way for buyers and sellers to agree on a price in a term sheet or sale agreement. They often include adjustments for working capital and net debt at the time of closing.
The use of a formula stops once the final purchase price is agreed upon and written into the final contract.
Variable Input
The Variable Input of valuation formulas includes figures such as trailing revenue and projected earnings. Analysts extract these numbers from audited financial statements to ensure the result is realistic. Any error in the base data leads to a flawed price.
Calculation Method
A neutral Calculation Method of valuation formulas defines the steps taken to reach the final number. A common method is the discounted cash flow.
Adjustment Trigger
An Adjustment Trigger of valuation formulas allows the price to change based on the actual performance of the company at closing. If the cash on hand is lower than a target level, the price is reduced dollar for dollar. This ensures that the buyer only pays for the assets that are actually delivered.
