BUSINESS VALUATION

- CA. Mandar Joshi

Valuation Meaning and Concept

Valuation implies the task of estimating worth or value of an asset, security

or business
In case of business valuation, the valuation is required of tangible asset such

as plant, machinery, building, land, equipment etc.,

Valuation

is also required of intangible assets like goodwill, patents,

trademark, brand name etc.

In some cases, valuation also involves valuation of human resources that run

the business.
Like assets, liabilities are also need to be valued by applying proper

valuation method.
Liabilities include liabilities recorded in books of accounts as well as

unrecorded liabilities, i.e., contingent liabilities.

Business Valuation: Common Uses of Business

Valuation
Tax
Estate/Gift
Buy/Sell Agreements
Bankruptcy and Litigation
Liquidation or Reorganization
Patent Infringement
Partner Disputes
Economic Damages

Employee Stock Ownership Plan

(ESOP)
Internal Revenue Codes (IRC) 743, IRC
409A, etc.
Solvency and Fairness Opinions
Damage Assessment
Dissenting Shareholder Actions
Marital Dissolutions

Financial Reporting
Purchase Price Allocation, Impairment Testing and Stock Options and Grants,
etc.
Strategic Planning/Transaction
Value Enhancement
Business Plan/Capital Raising
Strategic Direction, Spin-Offs, Carve Outs, etc.
Acquisitions, Due Diligence

Business Valuation Steps

Purpose of the valuation of

business
Understand the size &

characteristics of the
organisation

Selecting the business

valuation method
Applying the appropriate

Assessment of people and market

Gather additional data about the

organisation
Recast Financial Statements
Ratio Analysis/ Industry

comparison

valuation method
Adjustment as necessary for

the industry etc.

Final Valuation Report

Classification of Valuation
Methods
Business
Valuation
Methods

Asset based
valuation

Earnings
based
valuation

Methods of Business Valuation

Asset Based Valuation
Assets based valuation focuses on determining the value of net assets from the perspective of equity share valuation
Companys Net Assets are computed as under:
Net Assets (Net Worth) = Total Assets Total External Liabilities
Normally, value used while applying this method is book value of the assets and liabilities

Book Value
The book value of an asset refers to the amount at which the asset is standing in the books of the organisation on the date

of valuation.
The book value of the asset is generally initial acquisition cost minus accumulated depreciation on the same.
Accordingly, this method does not indicate the actual realisable or market value of the asset.

Market Value
Market value refers to the price at which an asset can be sold off in the market.
Under Market Value approach, assets shown in the Balance Sheet are revalued at the current market price.
Valuation of tangible assets is relatively easier than that of valuation of intangible assets such as goodwill, patents,

trademarks, brand etc.

While valuing intangible assets, it is essential to use satisfactory valuation methods based on amount of profits, capital

employed and average rate of return.

Methods of Business Valuation Contd.

Earning based Valuation
The earning approach or income approach is guided by the economic

proposition that business valuation should be related to the firms potential

earnings.
This method overcomes the limitation of asset-based approach, which

ignores the firms prospects of future earnings & ability to generate cash in
business valuation.
Earnings based
valuation

Based on
accounting
Capitalisation
method

Based on cash
flow basis DCF
approach

Capitalisation method of
valuation
The earnings approach of business valuation is based on two major parameters,

A) the earnings of the firm

B) rate of capitalisation

Earnings, for the capitalisation method, are normal expected annual profits.
For the purpose of this method, average profit for the past three to five years is considered.
Apart from averaging, profits are smoothen out to exclude the non recurring items in the financial

statements such as profit/ loss on sale of assets etc. This enables the valuer to determine future
maintainable profits of the organisation.
Second major factor in capitalisation method is rate of capitalisation to be used in the calculation.
Capitalisation rate is normally expressed in percentage terms and refers to the amount that an

investor is willing to invest to earn a specific income.

For example, 12% rate of capitalisation implies that the investor is prepared to invest Rs.100 if he

will earn Rs.12.50 in return. Similarly, in acquisition, acquiring firm is willing to invest Rs.100 to buy
the expected profits of Rs.12.50 of another business.

Discounted Cash Flow Method

Intrinsic Value (Discounted future cash inflows)
The intrinsic value of an asset is equal to the present value of future anticipated cash

inflows, more likely to be incremental.

Such cash inflows are to be discounted by using appropriate rate of return.
In case of business purchase decisions, its valuation is equivalent to the present value
of incremental future cash inflows
It simply represents the maximum price the buyer would be willing to pay for such an
asset.