Running Head: VALUATION APPROCH PAPER 0
VALUATION APPROACH PAPER
JEAN PAUL FRANCOIS
Liberty University
VALUATION APPROACH PAPER 1
Abstract
The primary objective of this project is to deliberate on the different valuations methods and
draw comparison on their resemblance and dissimilarities. Different valuation analysts may
incline to use a particular valuation technique, but conducting the best valuation of a company is
based on the kind of organization, the data accessible to the analyst, and the type of market.
Another goal of this assignment is to gauge on the attribution of each of the valuation technique
in determining the value of a business. Professionals in the financial industry and specifically in
business valuation have to make their due diligence to comprehend the valuation methods
because that is significant in the process of business decision-making.
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Business valuation
Business valuation is a method and a set of guidelines utilized to evaluate the economic value of
an “owner’s interest in a business”. These techniques are utilized by financial market experts to
determine the cost that they are inclining to pay or receive to influence the sale of a company.
Moreover, the valuation apparatuses are used to estimate the price that a seller willing be willing
to let go of a business. They are also utilized by business appraisers to resolve disputes “related
to estate and gift taxation, divorce litigation, allocate business purchase price among business
assets, establish a formula for estimating the value of partners' ownership interest for buy-sell
agreements, and many other business and legal purposes such as in shareholders deadlock,
divorce litigation and estate contest”. Every one of the valuation methods has its own guidelines
that provide the financial experts insights about the requirements for conducting the valuation
and this is always on a forward-looking basis (Hitchner, 2017).
Categories of valuation
There are three methods of valuing a business, and they are categorized as the income technique,
the market technique and the asset technique. Hence, prior to making the decision of choosing
the suitable valuation method, it is required to adjust the financial statements and in doing so,
there are three parts to take into account; and they are the “Generally Accepted Principles,
Normalization of adjustments and Tax adjustments”.
Every single organization has its own approach to business valuation since they all have aspects
in their companies that are different from one another. In addition, the value of a company may
be viewed different from an investor’s perspective to an owner’s perspective. Both the investor
and the owner may consider different parameters when valuing the company and that may result
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in generating bottom-lines that are widely varied (Modica, 2006). Also, the worth of a company
can be impacted by the time the valuation is being conducted and the conditions in involved in
the operations of that said organization. For example, bankruptcy may affect the value of a
company negatively if there is a pressed for time to finalize the process. Instead of taking the
time necessary to properly value the company and make the sales in due time, they go quickly
with the procedure and may sell at an undervalued price (Hitchner, 2017).
Income approach
The income approach is principally utilized to assess the value of an organization based on the
income stream produced from its operations. This is primarily used by an investor that put his
money into a company and needs to ensure that the fund invested will be recovered with the
proper rate of return which is the cost of let that money sitting there. The income method of
valuation is mainly concerned with cash flow generation of the business. The basic tenet of the
income technique is the view that the value of an investment is the aggregate of its present values
of the “future advantages it is anticipated to generate for the owner of the interest” (Modica,
2006).
When using the income method, the analyst takes into consideration the information available on
the financial statements and the income stream of the company. That really assists the financial
expert in discovering the attributing aspects that will attract the investor to the investment. This
tactic also presents an entire synopsis of the cash flows produced by the company. There may
be a slight difference in variation in the financial statement for smaller size organizations since
their tax’s situations are less complexed. There is a variety of information available about the
cash flow operation of the business, so business owners should be at ease when making decision
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(Hall, 2004). Professionals in the valuation field are well equipped to make accurate decision in
their analysis to assist individuals that are looking for their expertise.
Furthermore, when using the income approach to evaluate a business, there are three procedures
that financial experts may follow when dealing primarily with a private entity and they are
presented as such – the Discounted Cash Flow, Capitalized Cash Flow and Excess Cash Flow.
The aspects that impact these approaches are different even though the main objective of all of
them is to regulate the “future benefit streams” of the organization. The discounted cash flow
technique uses many different factors when included in the computation. The capitalized cash
flow approach primarily focusses on a simple calculation involving a numerator and a
denominator. The excess cash flow technique may be used as a fusion of the two aforementioned
approaches in order to discern the “value of intangible assets such as goodwill, patents, and
trademarks”. The most popular techniques utilized to evaluate specialized practices are the ones
that have direct relation to income and they are view as the “capitalized returns technique, the
discounted future returns approach and the excess earning approach” (Hall, 2004). Every one of
the approaches are primarily focused on the “present value of future cash flow and historical
data” to construct a dependable structure for valuation experts. “All other things being equal, the
more certain the future streams of cash flow are, the more valuable the asset or entity (Hitchner,
138).” The cash flow always takes into account the beginning income and expenditures to the
ending period income and expenditures.
Market approach
The market technique to business valuation assembles pricing information from sales
settlements, publicly trade organizations and the sales of interests in the marketplace (Hitchner,
291). Inherently, this method depends upon information from the actual marketplace to establish
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a company’s value. Comparable analysis is a key factor in determining the worth of a companies
since it analyzes the other similar organizations in the industry and that gives a standard for
analyst to rely upon for their data. It is necessary to know the “going rate” of similar businesses
in the industry because that provides some assistance in configuring the probable price the
business can be dealt for. Similarly, it is fair for buyers to be informed about the value of other
companies with the same scope in the industry, and that will give them clear insight into the
aspects that may affect them either negatively or positively before expressing their intensions to
conduct the transaction (Approaches to business valuation, 2016, Oct 14).
Advantages
There are several benefits derived from the market-based method of business valuation and that
encompasses: straightforward implementation and comprehension which incorporates the worth
of all of a company’s operating resources, tangible and intangible, and projections. One the most
common advantages of this methodology is that there is enormous amount of information
available on the organizations that are on the public market. “The Electronic Data Gathering,
Analysis, and Retrieval (EDGAR)” furnishes record on the information about those publicly
traded businesses as necessitated by the security and exchange commission (SEC) (Hitchner,
291). Moreover, the adjustment of information and information stages is demanded by the
Security and exchange commission and as a result, valuation analysts are permitted to investigate
any mixture date range, financial statements and market evaluation. In addition, the “stock price
and number of shares outstanding” may be used to calculate the market value whereas impulse to
market modification may rapidly activate stakeholders’ feedbacks. There are a number of
economic indicators that may impact the market-based method and that encompasses the size of
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the transaction, earnings, assets and capitalization, historical growth rates, movement among
resources, procedures of productivity and income stream. From the financial statement obtained
from EDGAR, valuation analysts may be able to appraise the “profit margins, the capital
structure of the business and assessment from the cash flow and earnings before income and
taxes. When used properly, the procedure to business valuation may be very efficient and may be
of great assistance to valuation experts (Bechtel, 2007).
Asset-based valuation approach
The asset-based approach to valuation is a much simpler method that the income and market
techniques, and it assesses a company based on its assets and liabilities. Even though this
methodology is straightforward, it still requires careful analysis in figuring out which assets and
liabilities to incorporate into the valuation. Since the analysis of the assets and liabilities involves
the use of the balance sheet which may complicate the process a bit because the balance sheet
contains historical data that does not reflect the fair market value of the items in there and as a
result, the outcome may be limited. Digging into the asset method involves a few stages such as;
appraisal of the balance sheet, reiterate documented assets and liabilities at fair market value,
assess the intangible assets and liabilities that are not registered on the balance sheet, and include
current and tangible assets and liabilities as cash, account receivable, and marketable securities
which are already recorded at fair market value. The two previously mentioned approaches are
the most commonly used, but the asset method is still a legitimate method (Reilly, 2017).
Moreover, the asset method can be utilized if an organization has continual losses.
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Comparison and contrast
There are many similarities among the three approaches, and there are as well some differences
that set them apart based on the evaluation of the points presented above. First, the asset-based
method is mostly utilized to value privately held organization and businesses that have
significant negative bottom-lines. Whenever, appraising a company that is in such position, the
appraisers should do their due diligence to ensure about the balance sheet in order to decide If a
sale is necessary or liquidation in bankruptcy. The market-based methodology utilizes the fair
market value and the going rate of comparable companies in the marketplace to figure out the
value, and likewise the asset-based method changes the assets and liabilities to fair market value
prior to finalizing the business valuation. In addition, the market and asset methods use the
significant aspects of industry performance, feedback and mandate for an organization’s
appraisal.
A difference that may be drawn is between the income method which uses the industry data less
than the asset and market techniques, but instead depends more on the financial ratios to assess
the most accurate appraisal of a business. However, it does have a similarity with the other two
approaches where it uses the financial statements to regulate the discounted cash flow, the
capitalizes cash flow and the excess cash flow evaluation calculations. Another difference is that
the asset and market methods incorporate intangibles items in the calculation, the income
technique does lack that aspect, and that is a significant attribute when selling a business since
goodwill by itself may bring in substantial amount of money when dealing with a big
organization.
It essential for appraisal experts to take into consideration all the approaches when conduction
valuation in order to determine which method that generates the best value of the organization in
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question. Going this route can be advantageous only if those valuations draw the same
conclusion. Since the atmosphere in the industry is not favorable, assessment of similar
organization should be used less while the focus should point to the discounted future income
stream, especially for small companies (Hall, 2003). The market-based method also has a
difference that serves as an advantage vis-à-vis the other two technique and is manifested the
sense of using historical information on a regular basis while the others have to translate that
information before incorporate it into their calculations.
Businesses necessitate the best appraisal in order to configure their worth, and that information
can be obtained from business valuators, but that data may not be accessible quickly due to the
nature of the business. When information is not easily accessible, the appraisers have to rely on
the process of trial and errors between the three approaches in order to find the most suitable
approach to use to conduct the valuation. It is essential to find the best valuation method to
appraise a business, and that furnishes both the seller and the buyer with the necessary
information to make the best decision.
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References
Approaches to business valuation. (2016, Oct 14). PR Newswire Retrieved from
http://ezproxy.liberty.edu/login?url=https://search-proquest-
com.ezproxy.liberty.edu/docview/1828458443?accountid=12085
Bechtel, R. (2007). Calculating human capital: The market-based valuation of the human
resource**. Zeitschrift Für Personalforschung, 21(3), 206-231. Retrieved from
http://ezproxy.liberty.edu/login?url=https://search-proquest-
com.ezproxy.liberty.edu/docview/225062771?accountid=12085
Hall, S. C. (2003). Comparable-companies business valuation in the current financial markets
environment. Journal of Financial Service Professionals, 57(1), 9-10.
Hall, S. C. (2004). Applying income-approach business valuation methods to professional
practices. Journal of Financial Service Professionals, 58(3), 91-99. Retrieved from
http://ezproxy.liberty.edu/login?url=https://search-proquest-
com.ezproxy.liberty.edu/docview/209615564?accountid=12085
Hitchner, J. R. (2017). Financial Valuation: Applications and Models. Hoboken, NJ: Wiley.
Modica, J. M. (2006). Business valuation 101: The fundamentals of business valuation in marital
dissolution matters. American Journal of Family Law, 20(3), 187-199. Retrieved from
http://ezproxy.liberty.edu/login?url=https://search-proquest-
com.ezproxy.liberty.edu/docview/275094078?accountid=12085
Reilly, R. F. (2017). The asset-based approach to business valuation in family law (part I of III).
American Journal of Family Law, 31(2), 69-80.
