Profit capitalization: how to determine the value of the business and its prospects
Profit capitalization involves the use of income that has not been distributed as dividends. The concept can also characterize the method by which the value of a business is determined based on its ability to generate income.
Profit capitalization has two ways, which allow to reveal the potential of an enterprise due to reasonable investment of earned funds.
The first option is called real. It involves reinvesting both in fixed and current assets. More often than not, long-term investments are chosen.
The second way is marketing. In this case, the value of the company is increased thanks to intangible assets. This type of capitalization is becoming more and more popular, the reason for which is the increased importance of business reputation and the desire to influence the value of the company.
The basis of capitalization is the concepts of bet and odds. The rate assumes the ratio of net yield to asset price, the result is fixed as a percentage. This indicator shows the profitability of the enterprise as a whole, but it is not an independent determining factor. It is possible to say exactly about the level of success and profitability of the business only after analysis with similar data obtained by investing in other options.
The profit capitalization ratio takes into account the net income of the company and the amount of cash that is used to increase its value. This value depends on the policy of the company.
To set the price of a business on the basis of its profitability, you need to know clearly the amount of capital that will allow you to get the right amount of capital with equal values of average loan interest and rates of return.
The company’s assessment is based on a number of factors:
- business analysis, volume of revenue;
- knowledge of the coefficient, which demonstrates the role of loan funds in the company’s turnover;
- determination of the period when the calculation is made;
- valuation of property.
This method is used only if the company has been observing this or that picture for a long time:
- business will be at the same level of development and profitability.;
- it will grow at almost the same rate.
In this situation the total value of the company will coincide with the value of its profitability, which is divided by the capitalization rate.
An important point is capital growth. When defining it, not only the equity capital of the business, but also credit funds are used. As a result, the role of the ratio increases, which shows the efficiency of borrowed money use. This factor consists of long-term and short-term amount of liabilities and equity capital of the enterprise. The higher the result of their ratio, the higher the risk for the entrepreneur. Such a business will not be of investment interest, as there is a high probability of not receiving money.