Valuation of business-basic

1. BUSINESS VALUATION
- CA. Mandar Joshi

2. 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.

3. 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
 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
– Employee Stock Ownership Plan (ESOP)
– Internal Revenue Codes (IRC) 743, IRC 409A,
etc.
– Solvency and Fairness Opinions
– Damage Assessment
– Dissenting Shareholder Actions
– Marital Dissolutions

4. Business Valuation Steps
• Purpose of the valuation of business
• Understand the size & characteristics
of the organisation
• Assessment of people and market
• Gather additional data about the
organisation
• Recast Financial Statements
• Ratio Analysis/ Industry comparison
• Selecting the business valuation
method
• Applying the appropriate valuation
method
• Adjustment as necessary for the
industry etc.
• Final Valuation Report

5. Classification of Valuation Methods
Business Valuation
Methods
Asset based
valuation
Earnings based
valuation

6. 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
• Company’s 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.

7. 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 firm’s potential earnings.
• This method overcomes the limitation of asset-based approach, which ignores the firm’s
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

8. 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.

9. 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.