session i-business valuation

7/31/2019 Session I-business Valuation

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BUSINESS VALUATION:I

By: K.P. ShashidharanDirector General O/o CAG of India

M.Sc. (London School of Economics),

CISA(USA), CFE(USA)Qualified Lead Auditor Environmental Management Systems(EMS, ISO 140001:1996)

Qualified Lead Auditor ISO 9001:2000Management Development Programme, IIM, Bangalore


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Topics covered in this session:

Concept of Value

Principle and techniques of Valuation


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CONCEPT OF VALUE:

A thing is worth whatever the buyer will pay for

it. Publilius Syrus.

WHAT IS VALUE:

The worth, desirability, or utility of a thing.

Worth as estimated.

The amount for which a thing can be exchangedin the market.

Purchasing power.

Estimate the value of, appraise.


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WHAT IS VALUATION:

The process of determining value.

Estimation of a things worth

Worth so estimated.

Price set on a thing


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More about VALUE:

How is VALUE different from Cost and Price?

What has VALUE?

Everything: Every Gods creation has value.

Why VALUE?

Who wants to VALUE?

When to VALUE?

Who determines VALUE?

What to VALUE?

How to VALUE?


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Types of VALUE:

Original Value Replacement Value

Book Value Market Value

Depreciated Value Economic Value

Sale Value

Purchase Value

Residual Value

Disposal Value/Scrap Value


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BUSINESS VALUATION:

Objective of any Management: Maximize corporatevalue and stakeholder wealth.

Analyzing a Company: understand the environment

(economic, industrial and social) and its internalresources and intellectual capital

Determining the present status of Company and tounderstand how to maximize the value of company

Business valuation requires an understanding offinancial analysis techniques in order to estimatevalue, and for acquisitions, it also requires goodnegotiating and tactical skills.


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Factors Determining Business Valuation:

The nature of the business and its history.

The book value and the financial condition.

The earning capacity of the company.

The companys earnings and dividend paying

capacity.

Goodwill or other intangible value.

The market price of the stock of corporations. The marketability of the securities.


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Misconception about Valuation:

Myth 1: It is an objective search for true value.

Myth 2: A good valuation provides a precise

estimate of value.

Myth 3: Valuing a private business should only bedone when the business is ready to be sold.

Myth 4: How much a business is worth depends onwhat the valuation is used for!


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Written valuation Report:

A written valuation report must summarize theappraisal procedures and the valuationconclusions.

It should consist of the following:

Company description.

Relevant valuation theory, methodology,procedures.

A valuation synthesis and conclusion.


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A summary of the quantitative and qualitativeappraisal.

A listing of the data and documents the valuerrelied on.

A statement of the contingent and limitingconditions of the appraisal.

An appraisal certification. The professional qualifications of the principle

analysts.


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Elements of Business Valuation:

1. Economic conditions: a study and understanding ofthe national, regional and local economic conditionsexisting at the time of valuation, as well as the

conditions of the industry in which the subjectbusiness operates, is important.

2. Normalization of Financial Statements:

Comparability adjustments: to facilitate comparisonwith other organizations.

Non-operating adjustments: Non-operating assetsneed to be excluded.


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Non-recurring adjustments: Items of expenditure orincome which are of the nonrecurring type need to beexcluded to provide meaning comparison betweenvarious periods.

Discretionary adjustments: Wherever discretionaryexpenditure had been booked by a company, they willneed to be adjusted.

3. Valuation Approach: There are three common

approaches to business valuation - Discounted CashFlow Valuation, Relative Valuation, and ContingentClaim Valuation - and within each of these approaches,there are various techniques for determining the fairmarket value of a business.


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Valuation Approach:

Discounted cash flow: This approach is alsoknown as the Income approach, where the valueis determined by calculating the net present value

of the stream of benefits generated by thebusiness or the asset.

Relative Valuation: This is also known as themarket approach. Comparing the assets of the

company with other company of same industry.

Contingent Claim Valuation: This approach usesthe option pricing models to estimate the value of

assets.


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Asset Based Approach:

a. The Liquidation value: Sale values of asset.

b. Replacement Cost: The current cost of replacing

all the asset of the company. Other Approaches:

a. Economic value added: the premise thatshareholder value is created by earning a return inexcess of the companys cost of capital.

EVA = NOPAT (Invested Capital x WACC)


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b. Performance based compensation: This effectivetool for motivating employees aligns their interestswith the shareholders. By tying compensation tocertain performance metrics, such as EVA or EVAimprovement, employees have a sense ofownership and strong incentives to help achievethe companys value creation goals.


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Choice of Approach

DCF Approach

Market Approach

Asset Based Approach

Cost Approach

For valuation of business,business Ownership interest orsecurity

For the valuation of an

intangible asset


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Fair Market Value:

Fair market value is defined as the price,

expressed in terms of cash equivalents, at whichhypothetical seller is willing to sell property and

hypothetical buyer is willing to buy in an open andunrestricted market.

It should be noted that there is no clear legaldefinition of fair market value, and it is not

automatically the market value. It is what the sellergives up and what the buyer acquires.


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Adjustment for valuation purpose:

A number of adjustments are required from the accountstatements of the company to be valued.

1. Income statement: Excess compensation, inventoryaccumulation, bad debts, depreciation, Corporate incometax.

2. Balance sheet: Inventory, Bad debts, fixed assetappreciation/ depreciation, patent, franchisee, goodwill,future royalties, tax loss carry forward.

3. General accounting policies: Overhead allocations,Installment sales, inventories, depreciation, income taxdeferrals, marketable securities, consolidation etc.


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session i-business valuation

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