Importance of business valuation

Posted by enterslicegroup on April 22nd, 2020

Business Valuation Overview

Business valuation

Business valuation is a process and a set of processes that is utilized to evaluate the economic value of an owner's interest in a business. Business Valuation is used by the members of the financial market to regulate the price they are agreeing to pay or receive the profits from sales. It can be used to determine the fair value of a business for various reasons, which includes sales value, ascertaining partner ownership and taxation.

Purpose of Business Valuation

Valuations must be used as a powerful element in the determination of the business is being managed and how the business activities are being undertaken. The purpose of a business valuation is to track the effectiveness of the premeditated decisions made and the process of initiating different strategies and provide the ability to track performance with regards to the estimated change in value, not only earned revenue.

Approaches for the calculation of the value of the business

When valuing a company as a going concern, there are three main valuation methods used by industry practitioners:

  • DCF analysis (Discounted Cash Flow)
  • Comparable company analysis
  • Precedent transactions

Business Valuation Methods

In this section, we will talk about the different methods used in order to calculate the economic value of a business. It is significant for a business to understand the various methods, as he will have to use them by undertaking these methods.

Asset Valuation

The first method is the evaluation of the total number of assets the company owns. The assets of the company consist of the tangible as well as intangible items. The market value of the assets is used in order to achieve the company’s worth.

Historical Earnings Valuation

The gross income of the company, capability to repay debts and capitalization of cash flow or earnings in a particular financial year determines its current value it is holding. If the business is finding it difficult to bring in enough income that could pay out the expenses, its business value is bound to drop. On the contrary, repaying the debt on time and maintaining a positive cash flow improves the business’s value. The mentioned factors are used to determine the business’s historical earnings valuation.

Relative Valuation

In this method of valuation, a comparison is undertaken with a similar business. The value of the assets of the business is compared to the assets to a business that contains similar assets and value is achieved.

Future Maintainable Earnings Valuation

It is significant to calculate the profitability that the business could bring in the future, which is the objective of this method. To calculate the business’s future maintainable earnings valuation, the evaluation of its sales, expenses, profits, and gross profits from the past three years are calculated and evaluated. These figures help the business predict the future and eventually provide the business value in the present.

Discount Cash Flow Valuation (DCF Valuation)

If profits are not expected to remain stable in the future, use the discount cash flow valuation method. It takes your business’s future net cash flows and discounts them to present day values. With those figures, you know the discounted cash flow valuation of your business and how much money your business assets are expected to make in the future. 

Documents Required for Business Valuation

For the purpose of evaluating and calculating the business value, there is a requirement of various documents. In this section, we will talk about all of those important documents. Details about Company Promoters, Key Management professional of the Company, Memorandum of Association, Article of Association, Prospectus, prior three years financial statements, a copy of the valuation engagement with the clients, these are some of the documents that are a necessary requirement from the business.

  • A copy of the previous valuation report of a subject matter of valuation exercise.
  • Documents which are relating to such assumptions & limiting the conditions in valuation assignment.
  • Information collected and analyzed to obtain the understanding of matters that may affect the value of the subject.
  • Documents pertaining to the selection of a valuation method which will be used in the valuation assignment containing the rationale and support for their own use.
  • Any restriction or limitation on the scope of a valuer’s work or the data available for the analysis
  • The basis for using the valuation assumption during the valuation engagement.
  • Documents pertaining to any rule of the thumb used in valuation, source(s) of the data used, as well as how the rule of thumb was applied.

Contents of Summarized Business Valuation Report

This section mentions some essential components that must be included in the valuation report. Taking into consideration important factors such as shareholders interest, necessity for transparency & upholding corporate governance principles as well as in view of the aspects of minority interest & corporate governance the Expert it is recommended that the following matters must be covered in summarized Valuation Report, in an unambiguous and in a manner that is not misleading and it must also maintain confidentiality.

  • Background Information
  • Purpose of Valuation & Appointing Authority
  • Identity of a valuer as well as any other experts involved in a valuation
  • Disclosure of interest of the valuer
  • Date of the appointment, the valuation date and the Date of Report
  • The Sources of different collected Information
  • The processes that must be adopted in carrying out the Valuation
  • The Valuation Methodology
  • Major Factors affecting a Valuation

Details Covered in Valuation Report

  • Brief particulars of company or business that is the valuation subject
  • Proposed Transaction
  • Key historical financials
  • The capital structure of the company, if necessary and any changes with regards to the proposed transaction
  • Shareholding pattern and any changes as a result of the transaction
  • Various mentions market volumes or price for the last six months wherever required
  • Related party issues with respect to different transactions.

General Principles of Business valuation

  • Value is determined at a specific point in time.
  • Value is perspective. It is equivalent to the present value, or economic worth, of all future benefits anticipated to accrue from ownership.
  • The determination depends on the market. It serves as an important factor when it comes to the estimation of the required rate of return.
  • The liquidity affects the value.
  • The value of the fundamental net tangible asset value base is closely related to the value in such a manner that higher the net tangible asset value is, the higher will be the concerned value.

Conclusion

The appropriate evaluation of any business is essential and therefore it must be conducted. Appropriate methods must be used and the business owners must ensure that the results are accurate. The accuracy of the results is important because it determines the worth of the business and predicts its future.

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