How to estimate software valuation and why you should?
With an ever-increasing rate of technological advancement, the demand for software and IT services is on the rise, and the software market is poised to reach $593.40 billion in 2022. To help keep pace with this phenomenal growth, we need to keep on innovating and creating more informed software value estimates.
Software valuation is the process of estimating the monetary value of software based on the actual and potential cost of producing and distributing the software and the expected benefits. To put it simply, software valuation is precisely the art of estimating the economic value of software products.
With the tech advancement, the development of software has grown drastically in all sectors; below image shows the overall growth of software and its valuation.
If we are to predict and estimate the economic value of software products, we need to know what drives the software business. As such, it is essential to evaluate the drivers and dynamics of the software market to put our estimates into context. The software market is rapidly evolving, and new business models, technologies, and behavioral and cultural trends are shaping how businesses move forward. The forward-looking nature of the software market forces us to constantly reevaluate our estimates, and this is why we need to keep on innovating. The first step in the business valuation software process is to identify and assess the software value drivers.
The Value Drivers of Software
The software market is driven by four main forces: technological innovation, the richness of functionality, adaptability, and documentation. In fact, we must measure the software market’s performance and define its growth in relation to these four forces.
Understanding how these forces impact the valuation of a company will allow us to make more accurate predictions and estimations. Let’s discuss each of the four main forces contributing to the success of the software industry:
Technology innovation is undoubtedly one of the main driving forces behind the software market. Innovations in data access and storage, processing capabilities, transaction management, and network security are driving demand for new hardware, creating new market opportunities for IT hardware and software providers.
The richness of functionality is an essential dimension in assessing the value of software. The rich and powerful functionality of modern applications provides businesses with enhanced decision-making capabilities, greater agility, and a competitive edge in the marketplace.
The adaptability of software gives us the opportunity to change and react to new trends quickly, which has driven demand for customized and tailored solutions in many industries (e.g., retail, finance, manufacturing, etc.). Businesses are leveraging cloud computing platforms to reduce costs and accelerate time-to-market while also improving the overall user experience.
Finally, software documentation is an essential element in creating value for software products. The rich set of information that modern applications provide can help businesses to achieve better business outcomes, lower costs, and improve customer satisfaction. But, what is the best business valuation software? Read on to know more!
Wondering how to properly estimate the value of software? — Here are the Valuation Methods
It’s important to start with a basic understanding of the different types of valuation methods. While there are various financial metrics that can be used as a business evaluator, the most commonly used methodologies are as follow:
1. Cost Approach — This approach is based on the actual costs of producing and distributing a software product. Typically, the cost to replicate the same software is identified, and this value is used to estimate the software value. Reproduction and replacement costs are the terms most commonly used in the cost approach.
2. Market Approach — This method takes into consideration comparing the transactions, including similar software products. Some of the measurable characteristics at which we can compare the software products are product popularity, complexity, breadth of functionality, and the reputation of the vendor.
3. Income Method — The income method has two approaches that value a software product based on future earnings, cash flows, or cost savings:
- Discounted cash flow (DCF) method, we can use a financial model to estimate the present value of projected future cash flow for certain time periods. It does this by estimating the annual cash flows, discounting them to their present values, and then summing up all of the discounted cash flows.
- Relief from the royalty method, this approach uses the present value of the costs that can be incurred in the case of software getting licensing from the arm’s length party. The notional license fees are estimated which are based on published license fees for similar software products published in intellectual property databases and other sources.
4. Trended Historical Cost Method — This approach is commonly used for software products where it quantifies the actual historical development costs, such as programmer labor costs (including payroll taxes, overhead, and profit element, however, excluding the time spent by programmers on maintenance) and then the time or trend is adjusted to the valuation date in regard with the inflation index.
5. Software Development Cost Models — Since every software product is unique and may have its own set of development characteristics, such as the complexity of the product, estimated production time, costs, program’s size and functionality, etc., the software development cost models are utilized in the software valuation. This method is used to compute the present value of the estimated costs incurred by developing the software. Wherein the present value of expected costs is computed by determining the present value of the estimated development cost.
Why Software Valuation?
Now that we have a basic understanding of how to value software products let us discuss why software valuation is critical.
From fundraising and mergers and acquisitions (M&A) to the creation of a joint venture and the acquisition of an existing business, the software valuation is a key factor in every stage of the software lifecycle.
The need for accurate software valuation lies in the fact that it is necessary to know the value of the software products in order to make the right business decisions, including the acquisition and financing process. In other words, the role of software valuation is to provide a framework for making the right financial decisions based on the value of a business, similar to how shareholders assess the value of the shares.
In addition, software valuation helps us predict a software business’s value, which means that companies can use this metric as an important indicator of future performance and results. Therefore, software product valuation is vital to the industry and thus becomes a critical part of strategic planning. Eqvista is here to provide you with the best valuation software. With years of experience, we help clients accurately value their software products. The experts at Eqvista are well-versed with the latest industry trends and capable of providing cost-effective, reliable, and timely valuation services. Visit now!
