Chapter:06

Basic of Valuation
INTRODUCTION
 Business valuation is the general process of
determining the economic value of a whole
business or company unit.
 Business valuation is typically conducted when
a company is looking to sell all or a portion of
its operations or looking to merge with or
acquire another company.
 The valuation of a business is the process of
determining the current worth of a business,
using objective measures, and evaluating all
aspects of the business.
Introduction
 Every assets, financial as well has value.
 The key successfully investing in and managing
these assets lies in understanding not only
what the value is, but also the source of value.
 Any assets can be valued ,but some assets are
easier to value than others and the details of
valuation will vary from case to case.
 Valuation of a share or a real estate property
will require different information and follow a
different format than the valuation of a
publicity traded stock
 Valuation is the process of determining the
current worth of an asset or a company; there are
many techniques used to determine value.
 An analyst placing a value on a company looks at
the company's management, the composition of
its capital structure, the prospect of future
earnings and market value of assets.
 Valuation is device to assess the worth of an
enterprise so that the consideration amount
can be quantified and price of one
enterprise for the other can be fixed.
 Such valuation helps in determining the

value of share of the acquired and acquiring

company to safeguard the interest of the
shareholder of both the companies.
Conceptualization of Value
 Book Value
 The book value of company refers to the

value which is obtained from the

balanceshhet by taking adjusted historical
cost of the company’s assets and subtracting
the liabilities.
 When the book value of tangible assets is

calculated in the same way as finding regular

book value, that of intangible assets are
possibility excluded in calculation
 Book value = Net worth = Total assets – Total
liabilities

 if Company XYZ has total assets of $100

million and total liabilities of $80 million, the
book value of the company is $20 million. In
a broad sense, this means that if the
company sold off its assets and paid down its
liabilities, the equity value or net worth of the
business would be $20 million.
 Total assets include all kinds of assets, such
as cash and short term investments,
total accounts receivable, inventories,
net property, plant and equipment (PP&E),
investments and advances, intangible assets
like goodwill, and tangible assets. Total
liabilities include items like short and long
term debt obligations, accounts payable,
and deferred taxes.
 Liquidation Value
 Liquidation is other benchmark of the
companies value. it is measure of the per
share value that would be derived if the firms
assets were liquidated and all the liabilities
and preferred stock were paid.
 Liquidation value may be more realistic

measure than book value

 If the firm is using its assets very efficiently,

the company’s value may be well in excess of

the liquidation value.
Fair Market Value

 Market value—also known as market cap—is

calculated by multiplying a company's outstanding
shares by its current market price.
 Market cap of a company=Current market price (pe
r share)∗Total number of outstanding shares
 If Company XYZ is trading at $25 per share and
has 1 million shares outstanding, then the
company's market value is $25 million. Market
value is most often the number analysts,
newspapers, and investors refer to when they
mention the value of a company.
 Economics Value
 The economics value is the value of the

expected earning from using the item

discounted an appropriate rate to give
present day value.
 The problem is not in defining the measure

but in actually estimating future earning

Business Valuation and its
importance
 Valuation can serve many purpose-to
establish a price, to help increase value, to
aid in estate planning, and to meet
governmental requirement.
 With a variety of business and legal situations

triggering the need to know the value of

business-strategic partnership, merger and
acquisition of business, estate planning,
Factor Determining value of A Firm
 Product: While evaluating, a purchaser must
consider not only the strength of a
company’s product in terms of design or
functionality but also what production
resource will be require and whether the
products will be good fit for its own product
line.
 Technology and intellectual property: At early

stage company’s value often hinge on the

strength of its intellectual property.
 Time market: Because purchasing company
brings new resources to a product
development effort , an acquisition will no
doubt decrease the time to market the new
product.
 Management: Human resource are an
essential part of acquisition transaction.
Some time buyer even acquire companies to
expand their management resource
 Market Acceptance: A buyer must determine
whetherprodcuts are likely to be accepted by
the market. To predict this, the company can
review the market share that the product
already have or use research to determine .

 Capacity: A buyer should consider the

production capacity of a potential acquisition
as well as its own production capacity.
 Corporate culture: The culture of the
companies as a whole is also critical in the
success or failure of the acquisition.

 Cash flow: Buyer should look at the cash

resources of a potential acquisition .
 If the purchases has access to a large amount

of capital, a cash poor company may actually

be good investment
5 Phases of Business Valuation
process
 Business Analysis
 Accounting Analysis
 Financial Analysis
 Forecasting Analysis
 Valuation models.
Business analysis Phase
 Business valuation aims to determine an intrinsic
value, on the basis of existing information about a
business and environment.
 The first phase in the process of valuation is
business analysis, which aims to identify
company’s value drivers and understand how they
are affecting the company.
 To achieve reliable valuation ,the appraiser should
accomplish an accurate business analysis before
determining final value .
 The quantitative method is that is always used to
obtain the company’s value, should be
complemented by qualitative methods
 The appraise should analysis the company, its
industry, its competitors, product,
research ,human resource, marketing etc to
understand how all theses aspects come
together to create the value for business
Business analysis phases include
1. External Analysis
2. Internal Analysis.
3. Economic Structure analysis
 External Analysis.:
 It is necessary to look at factors outside the
company that are not within the companies
control, but may have large effect on its
future development
 External analysis means examining the
industry environment of the company,
 External analysis include analysis of following

factors
 Innovation including new technology and the
Internet (of course) but other innovations too
which may be particular to an industry.
 Competitors. Not only direct rivals but threats

from substitute products, new entrants to the

market, the changing power of suppliers and
the changing power of customers. (These five
factors are known as the Five Forces of
Competition.)
 Economic factors such as inflation, exchange
rates, downturns in the industry, public
spending etc.
 Demographics. The relevant statistics of age,

gender, geography, social class etc, and

changes in these
 Infrastructure such as telecommunications

networks, transport, public services and

utilities.
 Internal Analysis
 Internal analysis often incorporates measures that
provide useful information about your
organization’s strengths, weakness, opportunities
and threats – a SWOT analysis.
 An internal audit inspects of the company, such as
goal and strategies product and services, product
life cycle, pricing and
differentiation,marketing,selling,supply
chain ,human resource and finance.
 The data generated by an internal analysis is
important because you can use it to develop
strategic planning objectives to sustain and grow
your business.
 Economic Structure analysis
Competition in the Industry
 The first of the five forces refers to the

number of competitors and their ability to

undercut a company. The larger the number
of competitors, along with the number of
equivalent products and services they offer,
the lesser the power of a company.
Potential of New Entrants Into an Industry
An industry with strong barriers to entry is
ideal for existing companies within that
industry since the company would be able to
charge higher prices and negotiate better
terms.
Power of Suppliers
The more a company would depend on a
supplier. As a result, the supplier has more
power and can drive up input costs and push
for other advantages in trade.
 Power of Customers
 A smaller and more powerful client base

means that each customer has more power to

negotiate for lower prices and better deals.
 A company that has many, smaller,
independent customers will have an easier
time charging higher prices to increase
profitability.
 Threat of Substitutes
 The last of the five forces focuses on

substitutes. Substitute goods or services that

can be used in place of a company's products
or services pose a threat. Companies that
produce goods or services for which there are
no close substitutes will have more power to
increase prices and lock in favorable terms.
Macro Economics Environment
 Company’s future development may be affected by
the environment where the company has its activity.
 To understand the environmental influence on the
company the STEP model can be applied.
 Socio-cultural, Technological, Economical and Political
 Socio cultural influence on company’s activity as
principles, primary valuation, preference and
behaviopur vary from country to country
 Socio cultural technological include following question
 1) Which districts dominate in the region?
 2) Which attitudes are there to companies product?
 3) How does the pollution structure look
Accounting Analysis Phase
 All Valuation model based on data from the
financial reports such as income
statements,balancesheet and cash flow
statement.
 The First step before valuation for the

appraiser is to inspect and study the

company’s financial data to better understand
trend in business activities and any
extraordinary activities.
 Balance sheet.
A balance sheet summarizes the financial
position of business at point in time. it is the
list of all the assets, liabilities and equity of
the business as of a certain date. The
development of balance sheet must follow
certain accounting regulations and standards.
 Income Statement
 Income statement consists of five classes of

items ,reven,expense gains,losses and special

item.
 The information about these classes is

helpful in forecsting,because it relates to

whether the item is likely to occur.
 Revenue and Expenses include

increase/decrease in net assets that result

from selling and producing good or services.
 Cash flow statement.
The reason for changes in the company's in
companies cash flow from the beginning to
end or a period are described in the cash flow
statement.
 Cash flow statement are divided in to 4 terms
 Cash flow from operating activities
 Cash flow from financing activities
 Cash flow from investing activities
Financial Statement Analysis
 Financial statement analysis is in important
part of the valuation process.
 Company’s financial statement the appraiser

can receive a host of information about the

company.
 These ratio help appraiser to understand

such thing as the company

profitability,growth,resource needs and
relationship among different financial items
Operating ratio

 Operating ratio are helpful in understanding

the profitability and capital efficiency.
 It will help forecasting and cash flow of the

business operations.
 If the estimated ratio deviate significantly

from the expected level, more precise

analysis should be done to determine the
source problem
 Credit Ratio
 Credit ratio measure a company ability to

repay obligations on a timely basis.

 The analysis of these ratio is especially

meaningful for valuation the company in the

matter of extending credits of the company.
 Company ‘s ability to repay its obligation

depends on general economic health

Investment ratio
 Investment ratio measure company total
performance and used along with the operating
ratios, to visualize potential investment.
 Many of the investment ratio combined
information from the income statement and
balance sheet.
 Price to earning ratio explains how many times
the yearly profit of the company is valued on
the market or expressed in another way how
much the market is ready to pay for every
month in profit.
Forecasting Phase
 In this phase of the valuation process the
appraiser uses all the information collected
about the company to predict the economic
performance in the future making a STEP
model.
 Appraiser have done a comprehensive work

about the company’s background and

possibilities.
 The item to be forecasted depend on the

selected valuation method of income based

approach
 It is important the Performa is logical and
coherent to existing accounting praxis.
 The forecast period which should be
predicted varies with how easy it is to be
describe the companies future development
and how available information about the
company.
 For some companies only short time period is

possible to forecast that’s is three to five

years because of big uncertainty.
 It is also important to make an analysis and

try the possibilities on the evaluated

forecasted value.