What is Value?
The term “value” encompasses different meanings to different people in different situations – from market value, strategic value, fair value (accounting and legal), liquidation value, net asset (book) value, going concern value, intrinsic value, to the investment values of both sellers and buyers.
What is Valuation?
The knowledge of the worth of an asset and what determines the value is a prerequisite for intelligent decision-making.
The analytical process of estimating the worth of a company or an asset is known as valuation. There are several methods for performing an evaluation. In addition to other factors, an analyst putting a value on a firm considers the management of the company, the make-up of its capital structure, the likelihood of future profits, and the market worth of its assets. It is a quantitative process of determining the fair value of an asset or a firm. A company can be valued on its own on an absolute basis, or else on a relative basis compared to other similar companies or assets.
There are several methods and techniques for arriving at a valuation—each of which may produce a different value. Valuations can be quickly impacted by corporate earnings or economic events that force analysts to retool their valuation models.
Therefore, the valuation may be described as the process of determining the worth of an asset or a company.
Objectives of Valuation.
For Transactions Purpose
- Facilitate the execution of key business transactions including:
− Mergers & Acquisitions (M&A).
− Leveraged Buy-out (LBO).
− IPO.
− Divestitures.
− Project Appraisal.
− Bankruptcy and Distress Securities Investing; and
− Private Investment in Public Entities (PIPE).
Compliance
- Ensure compliance with legal and regulatory requirements i.e., financial reporting, taxation etc.
- Compliance with commercial and tax law or other regulatory provisions requiring independent expert opinions on the fair market value of businesses and separate assets.
- Documentation of appropriate transfer prices.
Litigations
- Facilitate settlement of litigation claims in numerous areas including:
− Bankruptcy and restructuring.
− Fairness and solvency.
− Intellectual property litigation.
− Breach of contract and transactional disputes.
− Shareholder disputes.
− Divorce/family law.
− Lender liability.
− Tax-related litigations.
− Class action.
Enterprise Value vs Equity Value
“Enterprise value is the sum of claims of all the security-holders: debt holders, preferred shareholders, minority shareholders, common equity holders, and others on the business.”
“Equity value is the value directly attributable to the shareholders or owners of equity.”
The Importance of Valuations
- They serve as an indication of what you’re doing right and what you could be doing better.
- Valuations can help you determine ways to improve the business. Perhaps a valuation will indicate the need for a technology investment or hiring an employee.
- Valuations should be performed regularly; it provides a pretty good measure of how you’re doing compared to the path you’ve set for your business.
- The purpose of a valuation is to track the effectiveness of your strategic decision-making process and provide the ability to track performance in terms of the estimated change in value, not just in revenue.
- Whether it’s an external sale or internal next-generational transfer, valuation helps you to have an idea of what your business could be worth to a prospective buyer.
- If you are considering borrowing capital for an acquisition or other business investment, any lender will want to know what leverage lies in your business. Your valuation is the first step in the process of securing capital.
Methods of Valuation Models
Absolute valuation models look exclusively at the fundamentals in an effort to determine the intrinsic or “real” worth of an investment. Looking at fundamentals basically means ignoring all other firms and concentrating just on the dividends, cash flow, and growth rate of one particular company. The dividend discount model, discounted cash flow model, residual income model, and asset-based model are examples of valuation models that fit into this category.
Relative value models function by contrasting the in-question firm with other comparable enterprises. When using these techniques, multiples and ratios, including the price-to-earnings multiple, are calculated and compared to multiples of similar businesses.
Limitations of Valuation
It’s easy to become confused by the variety of valuation methodologies accessible to investors when choosing which one to employ to evaluate a stock for the first time. While some methods of valuation are quite simple, others are more intricate and difficult.
Unfortunately, no single approach is suitable for every circumstance. A diversity of valuation methods may be used since every asset is unique and every business or sector has distinctive qualities. The same underlying asset or firm will be valued differently by many valuation methods at the same time, which may prompt analysts to use the method that yields the best results.
How Is Valuation Calculated?
There are numerous methods for valuing things, and they vary depending on what and when is being valued. The fair value of a company’s assets and liabilities is a common calculation used to determine the company’s value. This computation is based on assets.
What Functions Does Valuation Serve?
The goal of valuation is to establish an asset’s or business’s value and contrast it with its present market value. This is done for a variety of reasons, including recruiting investors, selling the business, buying the business, offloading assets or parts of it, letting go of a partner, or passing the business down through inheritance.
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