BUSINESS VALUATION & ANALYSIS

UNIT I:VALUATION BASICS

• Concept of value and understanding of value.

• Nature and scope of valuation.

• Objectives of valuation.

• importance of business valuation.

• Myths about valuation.

• Business valuation approaches,

• principles, and techniques of valuation.

• Conceptual overview. Valuation approaches. Choice of

Concept of value and understanding of value
• The concept of value is the monetary, material, or assessed worth of an
asset, good, or service. In business valuation, value is the intrinsic worth
of a business, which is based on a variety of factors, including: assets,
market position, and ability to generate future cash flows.

• Value is a relative concept that can vary depending on the perspective of

the person assessing it. For example, a financial buyer might focus on a
business's cash flow and profitability, while a strategic buyer might value
it higher due to potential synergies.
Valuation
• The process of calculating and assigning a value to a company or asset is called
valuation. Some common types of value include: book value, enterprise value,
market value, and value stock

• Some principles that are important to consider in business valuation include:

• Risk and reward: Investors generally expect a higher return on riskier
investments.
• Present value: A rupee today is worth more than a rupee in the future.
Meaning of valuation
• Valuation is a quantitative process of determining the fair value of an
asset, investment, or firm. A company can generally be valued on its
own or an absolute basis or a relative basis compared to other similar
companies or assets.
Nature and scope of valuation

Valuation is an analytical process that determines the current or projected value of a company

or asset. The scope of valuation can vary depending on the type of valuation being conducted,

but some common factors to consider include:

• Nature of the business: The business's history, industry, and track record
• Economic outlook: The general economic outlook and the outlook for the specific
industry
• Financial condition: The company's book value, earning capacity, and dividend-paying
capacity
• Market value: The market prices of similar companies' stock
• Legal issues: Any legal issues that may impact the business
• Management: The company's management structure
Cont
• Capital structure: The composition of the company's capital structure
• Future earnings: The company's prospects for future earnings

Valuation results can fluctuate over time due to changes in market

conditions, industry performance, and general business conditions. The
method used for valuation depends on the purpose of the valuation.

Valuation is used in a variety of situations, including: Selling a company or

part of its operations, Mergers and acquisitions, Establishing partner
ownership, Taxation, and Divorce proceedings.
 Objectives of valuation
• The objectives of valuation are to estimate the value of an asset, and to identify the
areas of a business that contribute to its value:

• Determine the value of an asset: Valuation is a judgment of the equivalence between an

asset and a monetary amount.

• Estimate the cost of producing an asset: Valuation can estimate the cost of acquiring,
altering, or completing an asset.

• Estimate damages: Valuation can estimate the monetary amount of damages to an asset.
 Continued- Objectives of valuation

• Forecast earning power: Valuation can forecast the monetary earning

power of an asset.
• Identify value-generating areas: Valuation can identify the areas of a
business that contribute to its value.
• Consider interest or value: Valuation considers which areas of a business
may be of interest to the other party in a deal.
Importance of business
valuation
Business valuation is crucial for several reasons, particularly for decision-
making within a company and among investors.

• Investment Decision-Making: Investors use valuation to determine if a

company is worth investing in, guiding them on how much equity or stake
they can acquire.

• Mergers and Acquisitions (M&A): Valuation helps in setting a fair price for
both buyers and sellers during mergers or acquisitions. Accurate valuation
ensures that no party overpays or undervalues the business.
 Cont--

•Exit Planning: Entrepreneurs planning to sell their business rely on valuation to assess its worth,
aiding in negotiations and ensuring maximum returns.
•Raising Capital: Business owners use valuation to attract potential investors or lenders. The higher a
company’s valuation, the better its chances of securing capital.
•Strategic Planning: Understanding the worth of a business allows for informed decisions regarding
expansion, cost-cutting, or restructuring.
•Employee Stock Ownership Plans (ESOPs): Business valuation helps in determining the price at
which employees can buy stock in the company, aligning incentives.
•Litigation and Taxation: Valuation is often required for legal matters, including divorce settlements,
bankruptcy, or inheritance disputes. It is also essential for tax reporting, particularly with estate taxes or
shareholder disputes.
Myths about valuation:

Myth: Valuation is an Exact Science

• Reality: Valuation is not an exact number but an estimate based on various

assumptions, methodologies, and market conditions. Different methods can lead
to varying results, and the value may fluctuate over time.

Myth: Valuation Equals Market Price

• Reality: Valuation reflects the intrinsic worth of a business but doesn’t necessarily
match the current market price. The market price can be influenced by factors like
investor sentiment, short-term fluctuations, or market demand, while valuation
focuses on long-term fundamentals.
 Cont--
Myth: Valuation is Only Necessary When Selling a Business

• Reality: Valuation is useful in many scenarios beyond selling, such as fundraising, strategic
planning, resolving disputes, or setting up employee stock ownership plans (ESOPs).

Myth: Higher Revenue Always Means Higher Valuation

• Reality: Revenue is just one factor in valuation. Profitability, growth potential, and
operational efficiency are equally important. A company may have high revenues but low
valuation if it's not profitable or has high risks.
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Myth: Valuation Remains Static
•Reality: The value of a business changes over time due to internal factors (growth,
management changes) and external factors (market trends, economy). Therefore,
valuation must be regularly updated.
Myth: Only Large Companies Need Valuations
•Reality: All businesses, regardless of size, can benefit from knowing their value. Small
to medium-sized businesses often undergo valuation for investment, succession planning,
or partnership changes.
Myth: Valuation is All About Financials
•Reality: While financial performance is crucial, other factors like intellectual property,
brand strength, market position, and the quality of management also significantly
influence valuation.
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Myth: One Valuation Method Fits All
•Reality: Different valuation methods suit different business types and purposes.
Methods like discounted cash flow (DCF), comparable company analysis, or
asset-based valuation may be appropriate in different contexts.
Business valuation approaches
1.Income Approach: This method focuses on the future earning potential of the
business. It estimates the present value of expected future cash flows. Key methods
under this approach include:

• Discounted Cash Flow (DCF): Projects future cash flows and discounts them to
present value using a discount rate.

• Capitalization of Earnings: Divides the expected annual earnings by a capitalization

rate (often used for stable companies).
2.Market Approach: This method compares the company to similar companies or transactions C
in the market. Two popular techniques under this method are:

• Comparable Company Analysis (CCA): Compares the company to publicly traded

companies of similar size and industry.

• Precedent Transaction Analysis: Looks at recent sales or mergers of similar businesses to

determine valuation.

3.Asset-Based Approach: This approach values the company based on the value of its
assets minus liabilities. Two variations include:

• Liquidation Value: The net cash value if the company's assets were sold off and
liabilities paid.

• Book Value: The value of the company's assets as recorded on the balance sheet,
 Principles and techniques
The principles and techniques focus on determining the economic value of a business, which

is essential for mergers, acquisitions, financing, or legal purposes.

Principles of Business Valuation

Time Value of Money:

The value of money today is worth more than the same amount in the future due to its potential

earning capacity. Discounting future cash flows to present value is essential.

Risk and Return:

The expected return on an investment is linked to its risk level. Higher risks generally demand higher

returns.
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Market Efficiency:

This principle assumes that the market price of assets reflects all

available information. Market efficiency is a key consideration, though

valuation often involves determining whether a business is under or

overvalued relative to its market price.

Going Concern Principle: c
• Assumes that a business will continue operating indefinitely, affecting how future cash flows
are projected and valued.

Substitution Principle:

• The value of a business is determined based on the cost of substituting the business with
another similar investment, influencing the use of comparative approaches like market
comparisons.

Economic Profit:

• The value of a business is related to its ability to generate profits above the normal returns
expected by investors, which is why understanding operating income, cash flow, and
profitability is crucial.