This calculation variant is used to determine the value of unlisted shares and company interests under valuation law and is used primarily for tax purposes. Since the procedure within the Stuttgart procedure does not correspond to the IDW S1 standard or Czech valuation standards, this procedure is only suitable for calculation to a limited extent. The method places greater emphasis on net asset value (asset approach) than on capitalized earnings value (income approach). In addition, the capitalization interest rate and capitalization period are fixed from the outset. The Stuttgart method is used primarily in cases where the business value cannot be determined by the market comparison method and therefore needs to be estimated. The calculation is a simplification of important parameters - capitalization interest rate and capitalization period - and thus represents an alternative to otherwise very complex business valuation methods.
Business Valuation Methods
In practice, three basic approaches are used for business valuation – asset-based valuation, income-based valuation, and market comparison valuation. Combinations of these methods are also common.
These valuation methods are based on different principles, and the valuation result must be interpreted correctly.
Generally speaking, when a business "generates profit," we use the income method for valuation; when it "doesn't generate profit," we use the asset method. The ideal method for determining value is market comparison, which reflects actual transactions of similar assets in a similar market.
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Asset-based Valuation
The value of the business is formed by valuing individual asset items reduced by the value of debts. The principle of asset valuation is straightforward but is often considered conservative. In practice, asset methods are mostly used to determine the lower bound of business valuation and are widely used in cases where the "going concern" principle cannot be applied (continuation of business activities in future periods in an unchanged concept).
The basic methods include the accounting method reflecting accounting principles and asset and liability valuation policies, the substance method based on revaluing individual asset and liability items to fair values, and ultimately the liquidation value method determining what proceeds can be obtained from selling assets and settling liabilities including liquidation costs.
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Income-based Valuation
The business is viewed as a functional whole whose value is determined by what profits (cash flows) it is capable of generating for its owners in the future. For prospective businesses where the "going concern" assumption applies, this value is usually higher than the value determined by the asset approach. Income methods do not view the business as a set of asset and liability items, but as a functional whole that provides higher benefits when efficiently utilizing its assets.
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Market Comparison
The business value is based on already completed transactions (purchases and sales) of similar businesses carried out in a similar market. Theoretically, this approach should show approximately the same value as income-based valuation. However, it is important to realize that the difference between market or income valuation and asset valuation can represent a significant difference in the output value, even several times over. These large differences are caused by a lack of information about completed market transactions. The most well-known comparable transaction methods include EV/EBITDA and EV/EBIT ratios.
The EV/EBITDA ratio is a very popular valuation method used for business valuation (EV - Enterprise Value). It compares the value (or market capitalization) of the company adjusted for cash and debt. It is a more advanced version of the P/E (price-to-earnings ratio) as it takes into account the company's cash and debt situation. The EV/EBITDA ratio tells investors how many times they would have to pay for EBITDA if they wanted to acquire the entire business. Since the ratio is not affected by changes in capital structure (unlike the PE ratio), it allows for fairer comparison of companies with different capital structures. One of the main disadvantages is that this ratio does not take into account the growth rate and growth potential of the business, and because it uses EBITDA, it does not adjust for capital expenditures, which can be an important cost depending on the industry.
The EV/EBIT indicator is also a well-known valuation method and is calculated as the ratio between enterprise value (EV) and earnings before interest and taxes. It compares the company's price adjusted for cash and debt. The EV/EBIT indicator is similar to the P/E (price-to-earnings ratio), but uses enterprise value instead of market capitalization. Investors often use EV when comparing companies because EV provides a clearer picture of the company's true value as it includes financial leverage and cash. The EV/EBIT indicator is very similar to EV/EBITDA, with the main difference being that EV/EBIT includes depreciation. This is a significant difference for capital-intensive businesses where depreciation represents large economic costs. Like most multiples, however, it is important to keep in mind that this ratio does not take into account the growth rate and growth potential of the business.
Combined Methods
The mean value method is one of the classic combined methods. It is based on the idea that while capitalized earnings value represents the business value, determining this value is based on many uncertain factors, and therefore the existing substance (assets) should also be included in the valuation. The calculation uses a combination of net asset value and capitalized earnings value, which can be given certain weights.
The literature describes three approaches to determining business value using the mean value method:
- Mean Value Method (Berlin Method)
- Swiss Method
- Stuttgart Method
These methods are considered standardized and are used primarily for small and medium-sized businesses. It should be noted that the Stuttgart method is classified differently in the literature; on one hand, it is classified as a mean value method and on the other hand as an excess earnings method. In the case of the mean value method, it is a necessary prerequisite that the capitalized earnings value (income approach) equals or at least approximates the net asset value (asset approach). The reason is that an asset has value only if it can generate an appropriate return.
The mean value method (Berlin Method) was originally used between 1935-1955 to value unlisted shares in companies for tax purposes. Currently, this method is not used much anymore.
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Swiss Method
This method is also called the modified mean value method and is still very widespread in Switzerland. The capitalized earnings value is based on the assumption of constant periodic profits in the future, which leads to a present value in the form of a perpetual annuity. The Swiss method is recommended especially for companies with significantly higher capitalized earnings value, which usually results from a large amount of intangible assets.
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Stuttgart Method
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Excess Earnings Capitalization Value (WÜK)
In this method, the total company value consists of intrinsic value and goodwill. Here, goodwill is calculated by determining so-called excess earnings. For this purpose, expected profit is divided into two components. The first is interest on intrinsic value (normal profit). If you subtract this normal profit from expected profit, you get excess earnings. This is now capitalized at an increased interest rate to obtain the company value.
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Business Value by Temporary Excess Earnings Activation (WÜA)
This assumes that the seller is entitled not only to the reproduction value but also to an amount that compensates for giving up excess earnings in future years. After several years, excess profits can be paid out to the new owner (original goodwill) or gradually dissolved due to competitive pressure.