Business valuationManual

7

Introduction1

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Purpose 1.1Valuations of businesses, business ownership interest, securities

(hereinafter collectively referred to this forward referred as “Business

Valuation”) is the act or process of arriving at an opinion or estimation

of the indicative value of a business or an equity interest.

Business Valuation may be performed for a number of reasons

including, but not limited to, the following:

i. Mergers and Acquisitions.

ii. Tax related valuations.

iii. IPOs/Sukuks.

iv. Portfolio company valuations.

v. Internal management analysis for future decision-making.

vi. Dispute and litigation purposes.

vii. Accessing external sources of funding.

viii. Employee option / Stock plan.

ix. Regulatory compliance.

x. Financial Reporting

Consistency, objectivity and transparency are fundamental to building

and sustaining public confidence and trust in valuation. In turn, their

achievement depends crucially on possessing and deploying the

appropriate skills, knowledge, experience and ethical behavior, both

to form sound judgments and to report opinions of value clearly and

unambiguously to clients and other valuation users.

1.1.1

1.1.3

1.1.2

9

While valuation practitioners should apply a considerable amount

of judgment when valuing a company, they should comply with the

Saudi Authority of Accredited Valuers (Taqeem) code of ethics and

conduct for valuation profession. Further, Taqeem has written this

manual to establish a guideline, which covers the various nuances

of valuation and the complete engagement life cycle, to improve the

consistency and quality of the practice among Taqeem members

performing Business Valuation.

The manual was prepared on the basis that every valuation

engagement would need to go through four phases, as illustrated in

the page overleaf:

1.1.4

1.1.5

Refer to Appendix A for TAQEEM’s Code of Ethics and Conduct for Valuation Profession

Engagement ClosureReportingEngagement ExecutionPre-engagement

• Filing and archiving

• Closing instructions

• Managing repeat instruction

• Complains Handling

procedures

• The Valuation Analysis report

should contain the following

sections, as applicable:

• Valuation summary

• Statement of limiting

conditions

• Background

• Valuation analysis

• Annexure of valuation

workings

• Collect qualitative and

quantitative information

• Analyze information

• Develop valuation

conclusion

• Prepare valuation report

• Define the engagement

• Understanding and

communicating with the client

• Risk Management

• Planning for the work

• Team mobilization

• Calculation of fees proposal

• Engagement Letter

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This manual shall serve as a practical guide for valuation practitioners

(Valuers) about the business valuation process, from beginning to

completion. The manual lays out various steps that the Valuers should

undertake and describes the different valuation methodologies that

need to be considered in order to deliver a robust work product in

addition to laying out practical applications for determining the value

of a company.

For clients and other valuation users these professional standards

and valuation practice statements ensure:

i. Consistency in approach, aiding understanding of the valuation

process and hence of the value reported.

ii. Credible and consistent valuation opinions by suitably trained

Valuers with appropriate qualification and adequate experience

for the task

iii. Independence, objectivity and transparency in the Valuer’s

approach.

iv. Clarity regarding terms of engagement and purpose of

engagement, including matters to be addressed and disclosures

to be made.

v. Clarity regarding the basis of value, including any assumptions

or material considerations to be taken into account.

vi. Clarity in reporting, including proper and adequate disclosure

of relevant matters where valuations may be relied on by a third

party.

1.1.6

1.1.7

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vi. Clarity in reporting, including proper and adequate

disclosure of relevant matters where valuations may be relied on

by a third party;

vii. Clarity on valuation standards complied with; For example,

IVSC

viii. Limitations on the distribution of the report and permission

required to distribute beyond the contracting party;

ix. The information relied upon in arriving at the valuation

result;

x. The strength of the Valuer’s conclusion i.e. Valuation

opinion, estimate or calculation;

xi. Clarification that the value conclusion does not reflect

the “price” and that there may be many “prices” for a particular

business depending on such matters as negotiating strength,

potential buyer synergies, and many other factors;

xii. Whether a “special interest” purchase was considered in

the determination of the value.

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Glossary 1.2

Adjusted Net asset value (NAV): An asset valuation method where

all assets and liabilities are individually revalued including assets

and liabilities not on the balance sheet and assets are deducted from

liabilities to estimate value.

Arbitrage Pricing Model: An asset-pricing model, which predicts

an asset›s returns using the relationship between the asset and

macroeconomic risk factors. The model is similar to the Capital Asset

Pricing Model.

Articles of Association: A document that contains the guidelines

and purpose for a company’s operations.

Asset or Assets: To assist in the readability of the manual and to

avoid repetition, the words “asset” and “assets” refer generally to

items that might be about subject of a valuation engagement. Unless

otherwise specified in the manual, these terms can be considered to

mean “asset, group of assets, liability, group of liabilities, or group of

assets and liabilities”. 1

Basis of Value: Valuer must select the appropriate basis of value

when valuing business or business interest.2

1 The International Valuation Standards (IVSC), 2017 section 20.1 2 The International Valuation Standards (IVSC), 2017 section 30

13

Beta: A measure used to assess the systematic risk or volatility of a

single security or portfolio, in contrast to the market.

Build Up Model: A model used to calculate the required rate of

return on a security by adding various risk premiums. For example,

risk free rate, equity risk premium, size premium and company

specific risk premium.

Business Valuation: The practice of determining the economic

value of a company or business or ownership interest therein.

Capital Asset Pricing Model (CAPM): A model used to determine

the expected rate of return of a security by adding risk premium

to the rate on a risk free security. It defines the link between the

volatility and expected return of assets, specifically stocks.

Capital Market Authority (CMA): It is the Saudi governments›

financial regulatory authority responsible for capital markets in Saudi

Arabia.

Capitalization rate (cap rate): The rate used to determine the rate

of return of an asset/security. It is used as a discount rate for future

economic benefits of an asset/security, division that counts single

period cash flow.

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Capitalized Cash Flow Method: A valuation model where a single

estimate of economic benefits derived from an investment is counted

to value through division by a cap rate, which is then, discounted

using an appropriate capitalization rate.

Client: It refers to the person, persons, or entity for whom the valuation

is performed. This may include external clients (i.e., when a Valuer

is engaged by a third-party client) as well as internal clients (i.e.,

valuations performed for an employer). 3

Closed End Investment Companies (CEICs): Investment

companies listed on a stock exchange that raise a fixed amount of

capital through an IPO. The fund is then structured, listed and traded

like a stock on a stock exchange.

Company specific risk premium: The additional uncertainty

of expected return arising from factors other than those factors

correlated with the investment market, which an investor is expected

to generate by bearing extra risk related to the company.

Comparable Public Company (or) Guideline Public Company

method: A valuation method under the market approach, which uses

the market multiples derived from the investment prices of the public

traded companies in an open activity traded market in the same line

of business as the private company being valued.

3 The International Valuation Standards (IVSC), 2017 section 20.2

15

Comparable companies multiple: A financial metric used in

Comparable Public Company method to value a company, generally

the market value of a company’s stock or invested capital divided by

a company measure.

Comparable Transaction (or) Guideline Transaction method:

A valuation method under the market approach, which uses pricing

multiples as derived from acquisition transactions of significant

interests in public and private companies, which are engaged in

the same or similar lines of business as the private company being

valued.

Comparable transaction multiple: A financial metric used in

Comparable Transaction method to value a company. The typical

transaction multiple used is EV/EBITDA.

Compounded annual growth rate (CAGR): The annualized growth

rate of an investment over a period of time greater than a year.

Cost of debt (COD): The effective rate a company pays on its debt

obligations.

Cost of equity (COE): The rate of return equity holders expect

in return for investing in the equity securities of company i.e.

compensation for undertaking the risk of owning assets.

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Deferred tax asset (DTA): An accounting term reflected on a

company’s balance sheet, which illustrates a situation where a

company is due to pay taxes in advance of recognizing profits or has

tax losses, which can be used in future.

Deferred tax liability (DTL): An accounting term, which illustrates

a situation where a company is due to pay taxes later than the

recognizing of profits or has revalued fixed assets.

Discount for lack of marketability (DLOM): The discount applied to

determine the value of shares of closely held company and restricted

shares reflecting the absence of marketability.

Discount rate: A rate of return used to compute a future cash flow

sum into a present value.

Discounted Cash Flow (DCF) method: A valuation method under

the income approach, which discounts future benefit streams to a

present value using a discount rate.

EBIT: Earnings before interest and tax/zakat expense, represents the

operating income of the Valuation Subject.

EBITDA: Earnings before interest, tax/zakat, depreciation and

amortization expense.

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EBITDAt: It represents earnings before interest, tax/zakat, and

depreciation and amortization expense in the terminal period.

Engagement Letter: The legal agreement between a professional

firm and its client, detailing the scope of services in exchange for

compensation and other key engagement terms and conditions.

Enterprise value: It is the total value of a company, inclusive of both

debt and equity less liquid assets such as cash and investments.4

Equitable value: The estimated price for the transfer of an asset or

liability between identified knowledgeable and willing parties that

reflects the respective interests of those parties.

Equity risk premium: The additional rate of return over the risk free

return to reflect the additional risk of equity instruments over risk free

instruments.

Excess earnings: The Company’s anticipated earnings over the

required rate of return on the asset base, For example, working

capital and fixed assets.

Exit price: The price that would be received to sell an asset or paid

to transfer a liability.

4 The International Valuation Standards (IVSC), 2017 section 50.1

18

Fair value: The price that would be received to sell an asset or

paid to transfer a liability in an orderly transaction between market

participants at the measurement date. 5

Forced Liquidation or Forced Sale: Forced sale is often used in the

circumstances where a seller is under compulsion to sell and that,

as a consequence, a proper marketing period is not possible and

buyers may not be able to undertake adequate due diligence. The

price that could be obtained in these circumstances will depend on

the nature and pressure on the seller and the reasons why proper

marketing cannot be undertaken. 6

Fairness opinions: An independent Valuer expresses an opinion as

to financial fairness of the transactions such as private transactions,

non-arm’s length transactions relating to public securities, public

company takeovers, and significant acquisitions by public companies,

debt agreements or other security agreements.

Free cash flow to equity (FCFE): Cash flow available to the equity

holders of the company after all operating expenses, interest,

principal payments and necessary investments in working and fixed

capital have been paid/ made.

General Authority of Zakat and Tax (GAZT): A government agency

that reports to Ministry of Finance. Its objective is to assess and

collect tax/zakat from companies.

5 IFRS 13 6 The International Valuation Standards (IVSC), 2017 section 170.1

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Going concern: An accounting term for a company that will operate

into the future without the threat of a liquidation for the near future.

Gordon growth model: A valuation method, which determines the

intrinsic value of a stock, based on the economic income, which is

expected to grow at a constant average annual compound rate of

growth into perpetuity.

Gross domestic product (GDP): The economic value of all the

finished goods and services produced in an economy typically

over a year. It is one of the primary indicator to gauge the economic

performance of a country or region and to make international

comparisons.

Independence Confirmation: A statement confirming independence

from conditions and relationships, in the context of an engagement,

which would compromise the integrity or objectivity of the company

or person involved.

Information requirement list (IRL): A list sent to the client in order

to obtain relevant information of the client’s business available to use

in conducting a valuation.

Initial Public Offering (IPO): The shares of a private company,

which are sold to the public for the very first time.

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Intellectual property (IP): Intangible assets that enjoy special legal

recognition and protection, often by statutory authorities.

International Financial Reporting Standards (IFRS): A set of

international accounting standards stating how transactions and

other events should be accounted for in the financial statements and

to help investors and other users of financial information to make

economic decisions.

International Valuation Standards (IVS): Standards for undertaking

valuation assignments using generally recognized concepts and

principles that promote transparency and consistency in valuation

practice.

Investment value: It is an entity specific basis of value and represents

the value of an asset or investment to a particular owner or investor

based on their expectations.

Joint Venture: A joint arrangement where two parties have joint control

of the arrangement and rights to the net assets of the arrangement. It

normally involves sharing of resources, which could include capital,

personnel, physical equipment, facilities or intellectual property such

as patents. 7

7 IFRS 11 – Joint Arrangements

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Jurisdiction: The word “jurisdiction” refers to the legal and regulatory

environment in which a valuation engagement is performed. This

generally includes laws and regulations set by governments (e.g.,

country, state and municipal) and, depending on the purpose, rules

set by certain regulators (e.g., banking authorities and securities

regulators). 8

Liquidation value: It is the immediate value in cash that would be

generated from liquidating individual assets and investments in the

company; amount that could be realized when a Company’s asset

or a group of assets are sold on piecemeal basis. Liquidation value

should take into account the costs of getting the assets into saleable

condition as well as those of the disposal activity. 9

Market value: The estimated amount for which an asset or liability

should exchange on the Valuation Date between a willing buyer and

a willing seller in an arm›s length transaction, after proper marketing

and where the parties had each acted knowledgeably, prudently

and without compulsion. 10

Management Information Systems (MIS): A computerized

database of financial information, which provides management of

company regular reports on operations of a company.

8 The International Valuation Standards (IVSC), 2017 section 20.3 9 The International Valuation Standards (IVSC), 2017 section 80.1 10 The International Valuation Standards (IVSC), 2017 section 30.1

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May: The word “may” describes actions and procedures that Valuers

have a responsibility to consider. Matters described in this fashion

require the Valuer’s attention and understanding. How and whether

the Valuer implements these matters in the valuation engagement

will depend on the exercise of professional judgement in the

circumstances consistent with the objectives of the standards.11

Most advantageous market: The market that maximizes the amount

that would be received to sell the asset or minimizes the amount

that would be paid to transfer the liability, after taking into account

transaction costs and transport cost.

Multi factor model: A model, which incorporates various factors,

based on the risks of the investment to determine the required rate

of return of an asset/security. These factors could vary from size to

macroeconomic factors.

Must: The word “must” indicates an unconditional responsibility. The

Valuer must fulfill responsibilities of this type in all cases in which the

circumstances exist to which the requirement applies. 12

Net Income: Net income is a company’s total earnings (or profit) after

all expenses have been deducted from sales. It represents earnings

after deducting cost of goods sold, operating expenses interest,

gains and losses, and taxes for an accounting period.

11 The International Valuation Standards (IVSC), 2017 Glossary12 The International Valuation Standards (IVSC), 2017 Glossary

23

Non-disclosure agreement (NDA): A legal contract, which states

the confidentiality terms, shared between at least two parties. It

describes the information which could be shared between the

parties and which should not be accessible for the public.

Orderly Liquidation: The value of a group of assets that could be

realized in a liquidation sale, given a reasonable period of time to

find a purchaser (or purchasers), with the seller being compelled to

sell on an as-is, where-is basis. 13

Participant: The word “participant” refers to the relevant participants

pursuant to the basis of value used in a valuation engagement.

Different basis of value require the Valuers to consider different

perspectives, such as those of “market participants” (e.g., Market

Value, IFRS Fair Value) or a particular owner or prospective buyer

(e.g., Investment Value). 14

Price to earnings (P/E): The ratio of a company’s stock/share price

per share to the company’s earnings per share.

Profit after tax (PAT): The profit after deducting tax expenses.15

Purpose: The word “purpose” refers to the reason(s) a valuation

is performed. Common purposes include (but are not limited to)

financial reporting, tax reporting, litigation support, transaction

support, and to support secured lending decisions.

13 The International Valuation Standards (IVSC), 2017 section 160.1 14 The International Valuation Standards (IVSC), 2017 section 20.6 15 The International Valuation Standards (IVSC), 2017 section 20.7

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Quality and Risk Management (Q&RM): The practice of

identifying, quantifying, mitigating and managing a company›s risk.

It involves a team providing coordinated advice and assistance on

independence, conflicts, compliance, regulatory, policy, security

and risk management issues.

Rate of return: The income (loss) and/or change in the value of an

investment over a specified period of time in the market expressed

as a percentage of that investment.

Real Estate Investment Trusts (REITs): A corporation or trust that

uses pooled capital of money to invest in real estate through property

or mortgages and often trades on major exchanges like a stock.

Request for Proposal (RFP): A document, which solicits proposal

in which a company obtains funding for specific projects through a

bidding process between potential suppliers of capital.

Return on invested capital: A measure of the profitability of invested

capital, i.e., debt and equity capital.

Risk free rate of return: The rate of return available in the market on

an investment free of default risk.

Risk Management Action Plan (RMAP): A tool used by managers to

identify and estimate impacts of potential risks, along with solutions

to the risk issues.

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Saudi Arabian Market Authority (SAMA): The central bank of the

Kingdom of Saudi Arabia.

Scope of Services or Scope of Engagement: The fundamental

terms of the valuation services, which include purpose of valuation,

valuation subject being valued, Valuation Date, and responsibilities

of parties involved.

Shareholders Agreement: An arrangement among the company’s

shareholders designed to minimize disputes when more than one

shareholder is present in a corporation describing shareholders

rights and obligations and in matters such as transferring shares,

representation on board, protection of shareholders, etc.

Should: The word “should” indicates responsibilities that are

presumptively mandatory. The Valuer must comply with requirements

of this type unless the Valuer demonstrates that alternative actions,

which were followed under the circumstances, were significant to

achieve the objectives of the standards.

In the rare circumstances in which the Valuer believes the objectives

of the standard can be met by alternative means, the Valuer must

document why the indicated action was not deemed necessary and/

or appropriate.

If a standard provides that the Valuer “should” consider an action or

procedure, consideration of the action or procedure is presumptively

mandatory, while the action or procedure is not. 16

16 The International Valuation Standards (IVSC), 2017 Glossary

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Strengths, weaknesses, opportunities and threats (SWOT): A

structured planning method that evaluates a businesses’ competitive

analysis and elements in the environment it can exploit or should be

concerned about.

Subject of interest or Valuation Subject or Valuation Subject:

Refers to the company or assets valued in a particular valuation

engagement or project.

Tadawul: The primary stock exchange in the Kingdom of Saudi

Arabia.

Terminal growth rate: A constant rate, which assumes that a firm’s

expected income or cash flows, will grow indefinitely. It is used to

compute the terminal value of a company.

Terminal value: The value as of the end of the discrete projection

period in a discounted future earning model.

Valuation Approach: The fundamental method used by the Valuer to

determine the value of the Valuation Subject. The principal valuation

approaches are: (a) Market Approach, (b) Income Approach, and (c)

Cost Approach.

Valuation Date: The date on which the business is valued or

measured.

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Valuation Method: The particular detailed procedure, based on

one or more valuation approaches, used by the Valuer to obtain the

value of a company.

Valuation Purpose or Purpose of Valuation: See “Purpose”.

Valuation Technique: A specific analytical process of data treatment,

conducted within a valuation method.

Valuer: An individual, group of individuals or a firm who are accredited

by Taqeem and possess ability and experience to execute a valuation

in an objective, unbiased and competent manner. In Saudi Arabia,

licensing from Taqeem is required before one can act as a Valuer. 17

Weight: The word “weight” refers to the amount of reliance placed

on a particular indication of value in reaching a conclusion of value

(e.g., when a single method is used, it is afforded %100 weight). 18

Weighted Average Cost of Capital (WACC): The overall cost of

capital (discount rate) determined by the weighted average, at

market value, at the cost of all liquid sources in a business’s capital

structure.

Zakat: Companies owned by Saudi and GCC investors are liable

for Zakat, a religious obligation. Zakat is charged on the company’s

Zakat base at %2.5; zakat base represents the net worth of the entity

as calculated for Zakat purposes 17 The International Valuation Standards (IVSC), 2017 section 20.1318 The International Valuation Standards (IVSC), 2017 section 20.14

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References 1.3

“International Valuation Standards, 2017”, International Valuation

Standards Council, Pg. 15-14

“Statement on Standards for Valuation Services – Valuation of a

Business, Business Ownership Interest, Security or Intangible Asset,

June 2017”, American Institute of Certified Public Accountants, Pg.

35-22

“The HKIS Valuation Standards, 2012 Edition”, The Hong Kong

Institute of Surveyors, Pg. 48-41

“Practice Bulletin Number 3 – Guidance on types of Valuation

Reports”, The Canadian Institute of Chartered Business Valuators

“European Valuation Standards, 2016 (Eighth) Edition”, The European

Group of Valuer’s Associations, Pg. 77-67

Valuing a Business – Shanon Pratt

AICPA Business Valuation Standards

Cost of Capital 5th Edition, Shannon P. Pratt, Roger J. Grabowski and

Richard A. Brealey

1.3.1

1.3.2

1.3.3

1.3.4

1.3.5

1.3.6

1.3.7

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31

Pre-engagement2

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Engagement Acceptance2.1

Engagement acceptance is an important process, through which

the Valuer determines whether to accept a new client and undertake

an engagement with him/ her, subject to both external factors (For

example, Government regulations) and internal factors (For example,

policies and competencies).

The Valuer should be guided by ethical, moral and legal policies of

his/ her company while accepting the engagement with any company/

entity.

Understanding the purpose of valuation, the intended users of the

report and what do they intend to use the valuation for is critical

before acceptance of the client. The Valuer should gather information

on the engagement, the competencies required for the scope of

work, size and pricing of the engagement, the engaging client’s

background, reputation, and any potential risks. The Valuer should

also take into consideration the likelihood that the valuation would

lead to litigation and/or the public scrutiny before acceptance of the

client and engagement.

2.1.1

2.1.2

2.1.3

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The Valuer should conduct background checks of engagement

client, valuation subject and counter parties to assess engagement

risk, financial and reputation risk, any potential impairment to the

Valuer’s brand by associating with the engaging client, valuation

subject or counter parties. In addition to these background checks,

the Valuer should also check if there are any independence issues,

perceived conflict of interest, time limitation or absence of reliable

information to complete the engagement, fee contingent on the

valuation outcome. Based on the all these outcomes, the Valuer may

decline the engagement.

The Valuer should also comply with TAQEEM’s requirement on the

qualification of the team working on the valuation engagement.

As per the TAQEEM’s guidelines, the Valuer should be an active

member of the TAQEEM who has the basic qualifications of one

of the active business membership categories (refer to TAQEEM’s

guide on “Implementing Regulations of Accredited Valuers Law”).

2.1.4

2.1.5

Refer to Appendix B for Implementing Regulations of Accredited Valuers Law.

Refer to Appendix C for Sample Client and Engagement acceptance form.

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Understanding and communicating with clients2.2

Before commencing any work, it is essential to get clarity on the basic

details about the engagement as described below.

Valuation Subject

2.2.1

2.2.2

2.2.2.1

2.2.2.2

2.2.2.3

The ‘Valuation Subject’ or ‘Subject of Interest’ represents the

business or equity stake that is required to be valued. Sometimes,

the client requires only a part of the overall business to be valued

– this could be a subsidiary, a particular project, a joint venture of

the client, an investee company, a business division or a specific

carved-out component of the business. Alternatively, only the

assets of a business could require valuation – these could be the

tangible assets or the intangible assets or both.

It is not only important to know the Valuation Subject but also

to understand it in detail, as that forms the basis for the entire

engagement execution and administration.

A few important questions to ask in order to understand and define

the Valuation Subject in greater detail are listed below:

i. Is the Valuation Subject a public/listed company or a private/

unlisted company? If private company, it is important to identify

the following:

a. Who are the shareholders? b. Is there a shareholder’s agreement? c. What are the rights of the shareholders?d. Do they have control interest or minority interest? e. What is the degree of marketability of their interest inValuation Subject?

35

ii. What industry/industries does the Valuation Subject operate

in and the outlook of the industry?

iii. Does the company have downstream entities that need

to be valued such as subsidiaries, associates, joint ventures,

special-purpose vehicles (SPVs) that are set up for executing

projects, investee companies, etc.?;

iv. Does the company have business divisions that need to

be fair valued separately? For instance, a conglomerate could

have various businesses – each may not be under a different

subsidiary, but they may still have independent Management

Information System (MIS) structures and financial statements.

It may be necessary to consider these individually since

considering the whole company together may not appropriately

capture the true value of each business division;

v. Are there intangible or tangible assets that need to be fair

valued separately?

vi. Does the engagement involve valuation of one entity or

multiple entities? For example, in the case of a merger or a

share swap, both entities need to be valued;

vii. What is the Purpose of valuation?

viii. What information is available in accounts of the consolidated

financials of separate divisions of a conglomerate business?

Are projections available for the valuation subject?; and

ix. What is the Valuation Date?

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2.2.2.4

2.2.3.1

2.2.3.2

2.2.3.3

A clear understanding of what needs to be valued is critical to

ensure there is no ambiguity regarding the scope of work and to

prevent misunderstanding from arising, subsequently, during the

engagement.

The ‘Engaging Client’ refers to the client contracting for the services

of a professional the Valuer.

Understanding the purpose of valuation, the intended users of the

report and what do they intend to use the valuation for is critical

before acceptance of the client.

Understanding the role the Engaging Client plays in relation to the

Valuation Subject helps to understand their perspective and take

into account any bias they may have when preparing the business

plan for the Valuation Subject. For example, an existing shareholder

would look at maximizing value whereas a potential investor may

prefer a lower value so that their price of investment is reduced;

such biases may need to be addressed in the course of the

valuation engagement; for example, any valuation analysis where

the fee is conditioned on the outcome of the valuation will result in

biased analysis. If the Valuer or Engaging Client want transaction

driven valuations to be unbiased, the Valuer or Engaging Client

should separate the deal/valuation analysis from the deal making

team to reduce any perceived/ actual bias.

Engaging Client2.2.3

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2.2.3.4 The Valuer or Engaging Client can mitigate the effect of any

perceived or actual bias through the following:

i. Reducing institutional pressures: Institutions that want

reliable/credible sell-side equity research should protect their

equity research analysts who issue sell recommendations on

companies, not only from companies but also from their own

sales people and portfolio managers.

ii. De-linking valuations from reward: Any valuation analysis

where the reward is conditioned on the outcome of the valuation

conclusion will result in biased valuation.

iii. No pre-commitments: Decision makers should avoid taking

strong public positions on the value of a firm before the valuation

is complete.

iv. Self-awareness: A Valuer who is aware of the biases he/

she brings to the valuation analysis can either actively try to

confront these biases when making input choices or open the

process up to more objective points of view about company.

and

v. Honest reporting: Valuation would be more useful if the

Valuer revealed their biases up front.

While the Valuer cannot eliminate bias in the valuation, the Valuer

can try to minimize the impact of bias by designing valuation

processes that are more protected from explicit outside influences

and by reporting the biases with estimated values.

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2.2.3.5

2.2.3.6

In addition, knowing the Engaging Client and their role in relation

to the Valuation Subject helps in making certain key decisions

pertaining to the valuation approach. The knowledge of the

Engaging Client also helps to approach the valuation from the

context of its end-use.

Some key questions that help to identify the role of the Engaging

Client in relation to the Valuation Subject are listed below:

i. Are they existing providers of finance (equity or debt, as the

case may be)? These could be individuals, corporates, private

equity funds, venture capitalists, banks, financial institutions,

sovereign funds, or any party that has a financial interest in the

company;

ii. Are they third parties wishing to acquire stake in the valuation

subject – will they be investing in terms of equity or debt? Similar

to the existing providers of finance, these could fall in any of the

categories mentioned above;

iii. Are they responsible for management of the valuation

subject (For example, key officials such as CFO, CEO, finance

and strategy heads responsible for major decision-making in

the organization)?

iv. Is the Engaging Client in a position to provide the information

required for the valuation engagement?

v. Do they have sufficient understanding of the industry to

provide meaningful input to the valuation process?

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Purpose of Valuation2.2.4

2.2.4.1

2.2.4.2

Knowing the purpose of the valuation is an important pre-requisite

to a valuation engagement since valuation for the same entity/

asset could be different under different circumstances.

i. It is important to be clear on the intended users of the

valuation report and purpose of valuation to ensure the analysis

is sufficient in accordance with the purpose and scope of the

valuation. For example, Valuation analysis and results will be

different for the purpose of financial reporting and purpose of

helping management in investment decision. Hence, it is very

critical to limit the intended use of the report to specific purpose/

requirement of the valuation.

The following details the various purposes for which a valuation

may be required. The list is not exhaustive as there would be other

reasons to conduct business valuations:

i. Deal/Transaction related valuation: to provide negotiation

support for any on-going or potential transaction which

includes private financing / venture capital funding, IPOs/

Sukuks, mergers and acquisitions, bankruptcy, joint venture

contributions, capital (debt/equity) infusion, fairness opinion;

ii. Strategic related valuation: to support internal analysis

for any on-going or potential transaction, capital structure

assessment and/or structural business changes such as

mergers & acquisitions, divestitures, IPOs/Sukuks.

40

iii. Liquidation: to estimate the immediate value that the seller

may realize from selling off or liquidating the assets in company.

iv. Compliance related valuation: to comply with financial

accounting standards and tax/zakat reporting. Compliance

related valuations include the following:

a. Financial reporting

Valuation for financial reporting can be for impairment testing

of goodwill, impairment of long-lived intangible assets, and

fair value of investments held.

1. Purchase Price Allocation valuations provide valuation estimates

relating to tangible assets, intangible assets, liabilities and equity

interests acquired in a transaction. The services can also include

providing the fair value of contingent considerations;

2. Valuations for impairment testing provide valuation estimates

relating to the annual or periodic impairment testing of goodwill and

long-lived intangible assets, as well as the annual or periodic testing

of certain fair-value accounting estimates; and

3. Valuations for fair value of investments held provide valuation

estimates relating to the fair value of equity investments held for

disclosure purposes or for other investments that require periodic fair

value measurements.

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b. Tax reporting

Valuations for tax reporting involve the preparation of

valuations for various tax requirements including, but not

limited to share reorganizations and capital gains tax.

v. Dispute related valuations: valuations for dispute resolution

and litigation support include the following:

a. Expert Determination

Independent valuations of corporations in accordance

with Articles of Association, Shareholder and Joint Venture

Agreements;

b. Expert Witness

Either as an independent expert witness or as an advisor

to one of the parties in the context of litigation, arbitration,

or mediation where there are valuation issues (breach

of warranty claim, significant business interruption, and

professional negligence). If the Valuer is an independent

expert witness, independence and duty to the court or

tribunal is paramount.

c. Regulatory purposes:

These are performed to comply with legal requirements of a

jurisdiction or regulatory requirements.

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2.2.4.3

2.2.4.4

2.2.4.5

When considering valuations for mergers and acquisitions,

difference could arise depending on whether the engaging entity

is on the buy-side or the sell-side since buyers may have a different

business plan as compared to the seller. In this respect, the Valuer

needs to be capable of assessing any potential synergies from a

merger/ acquisition that may result in realizing a higher value.

Under financial reporting, specific guidelines may need to be

followed for the valuation depending on the accounting standards

or any valuation standards that are applicable to the business.

For example, International Financial Reporting Standard (IFRS) 3

for purchase price allocation (which will be discussed further in

the module on ‘Types of Valuation’) stipulates that the Valuer may

need to take into account the value of the business at the time of

investment (if it is a recent one) or the book value of the investment

(for older ones) to assess if there is any impairment in the same.

Valuation for regulatory compliance are usually related to filings

with General Authority of Zakat and Tax (GAZT) (i.e. tax authorities),

Saudi Arabian Monetary Authority (SAMA), Capital Market Authority

(CMA) or court. The valuation in such cases may need to take into

account restrictions, guidelines and any specific requirements

outlined by the respective regulators in performing the valuation

and arriving at a value conclusion.

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2.2.4.6

2.2.4.7

Valuations for creditors/financial institutions are usually required

from the perspective of assessing whether the collateral offered

is commensurate with the loan funds being disbursed by the

institution. Depending on what point of the loan cycle the valuation

is sought, the approach may need to be optimistic, realistic or

conservative depending on the purpose and basis of the valuation.

For instance, if the valuation is sought prior to disbursal, it may

consider an optimistic or realistic business plan but if it is sought

after the company has defaulted on its loans, then a conservative

view may be preferred, since the business may be valued under a

distressed situation.

Lastly, when a valuation is required for internal decision making

such as organizational restructuring, strategic planning and similar

situations, the valuation may need to consider various possible

options and business plans in the valuation, which could give rise

to complexities in the valuation exercise. As compared to regulatory

or financial reporting valuations, carrying out such engagements

may take a longer period depending on the depth of the review

and result in multiple iterations. This needs to be identified and

acknowledged while scoping the project and negotiating timelines

and fees so that appropriate decisions can be taken regarding the

same.

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Basis of Value2.2.5

2.2.5.1

2.2.5.2

The Valuer should be very specific about the definition of value that

will be used when valuing the Valuation Subject. As assets may

have a different value, depending on the basis used, the basis of

value may influence or dictate the Valuer’s selection of method,

inputs and assumptions, and the ultimate opinion of value.

The Valuer must select the appropriate basis of value when valuing

business or business interest. This section defines certain basis of

value to be considered for various valuation purposes:

i. Market value: The estimated amount for which an asset

or liability should exchange on the Valuation Date between a

willing buyer and a willing seller in an arm’s length transaction,

after proper marketing and where the parties had each acted

knowledgeably, prudently and without compulsion.

ii. Equitable value: The estimated price for the transfer of an

asset or liability between identified knowledgeable and willing

parties that reflects the respective interests of those parties.

It requires the assessment of the price that is fair between

two specific, identified parties considering the respective

advantages and disadvantages that each will gain from the

transaction; hence, the price that is equitable between them is

different from the price that might be obtainable in the market.

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iii. Fair value: It is the basis for the valuation required for financial

reporting under IFRS, tax reporting and/or litigation purposes.

IFRS 13 defines fair value as the price that would be received to

sell an asset or paid to transfer a liability in an orderly transaction

between market participants at the measurement date.

iv. Investment value: The value of an asset to a particular

owner or prospective for individual investment. Investment value

is an entity-specific basis of value and may be higher than fair

value depending on potential buyer. Investment value includes

possible synergies, goodwill from brand recognition and other

owner specific factors. Accordingly, the investment value

estimated would be regarded as the upper limit to how much a

potential buyer would be willing to pay for an asset.

v. Synergistic value: Synergistic value is the result of a

combination of two or more assets or interests where the

combined value is more than the sum of the separate values.

Synergistic value will reflect particular attributes of an asset that

are only specific purchaser.

vi. Liquidation value: Liquidation value of a company is the

immediate value in cash that would be generated from liquidating

individual assets and investments in the company; amount that

could be realized when a Company’s asset or a group of assets

are sold if the Company were to go out of business.

Refer to Appendix D for Liquidation Value

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Level of value 2.2.6

2.2.6.1

2.2.6.2

The Valuer should be very specific about the level of value that

will be used when valuing the percentage of interest in Valuation

Subject; the specific ownership interest characteristics such as

control (or lack of control) and marketability (or lack of marketability)

should be taken into consideration.

The levels of value in term of characteristics of control to be

considered for valuation purposes are as follows:

i. Controlling interest value: The value assigned when the

holder of stocks has control over the company’s business

activities by virtue of their ability to influence management and

policies of the company;

ii. Purpose of valuation: Level of value can be influenced by

the purpose of valuation. For example, when the purpose of

valuation is to support the negotiations of a potential acquisition

of a private company, a discount for marketability may not be

appropriate in the valuation analysis.

iii. Marketable minority interest value: The value assigned when

holders lack control over the company’s business activities but

have the ability to sell the investment at will

iv. Non-marketable minority interest value: Value assigned

when holders lack control over the company’s business activities

and lack the ability to sell the investment at will.

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Valuation Date2.2.7

2.2.7.1

2.2.7.2

2.2.7.3

2.2.7.4

2.2.7.5

The Valuation Date is the specific date at which the Valuer analyzes

the value of Valuation Subject.

Defining the Valuation Date in advance is important as the date

defines what information is considered in the analysis.

The Valuation Date may either be as of the current date or some

date in the past and cannot be a future date. The value estimate

should always be dated as company, industry, general economic

and capital market conditions are constantly changing, and the

valuation should be developed without the benefit of hindsight.

Since valuation relies to a great degree on company financial

statements and the availability of reliable financial statements as

at the Valuation Date is extremely important. For example, if a

client approaches the Valuer for valuation as at 31 December of

a particular year, the latest available financial statements as at 31

December, should be considered in the analysis.

However, certain situations require the valuation to be as of

transaction date or some other particular date. In such cases,

the client would necessarily be required to draw up the financial

statements as at that date for the valuation exercise, even if it is

not part of the routine filings. Accordingly, in the above situation,

if the valuation were prepared as of 25 February, then financial

statements would also need to be provided as of that date.

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2.2.7.6

2.2.8.1

It is important that the value of a company as provided on the

Valuation Date should only take into account all known events

up to the Valuation Date and conditions existing at the Valuation

Date. The unknown events as at the Valuation Date should not

be considered, even if the unexpected subsequent events can

change the relative value of a company. Examples of unexpected

subsequent events includes changes in customer/product

concentrations, changes in dividend or distribution policies,

recapitalizations or stock repurchases, engaging in IPO, market

crashes or surges, unexpected failure of a competitor, unexpected

loss of a key supplier or manager, unexpected regulatory change,

and natural disaster unknown to the Valuation Subject as at the

Valuation Date.

Information requirements must be spelled out in the engagement

letter or contract. Most of the information can be easily sought

on the initial call, a meeting or via any means of communication

that is convenient to all the parties involved. However, it is always

advisable to minute these discussions over email to ensure

alignment in understanding. the necessary information is required

to perform the valuation needs to be explicitly identified as

part of the engagement agreement that is to be signed prior to

commencement of work.

Information gathering2.2.8

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2.2.8.3

2.2.8.4

2.2.8.6

Another step to be undertaken at this stage is to prepare an

information requirement list (IRL) required for the valuation.

Providing this to the client early helps expedite the engagement

and gives an opportunity to discuss the extent of data that would

be available for the valuation. This helps to understand limitations,

if any, arising due to data gaps.

The information requirement list will depend on the nature of the

valuation assurance provided and the company being valued,

which would typically cover the following aspects:

i. Qualitative aspects pertaining to the business:

a. Corporate profile/presentation outlining the following:

1. Various business segments, products and services, such as

2. Organizational chart;

3. History of company and significant corporate events;

4. Minute of board of directors meeting;

5. Industry and competition data and industry trends;

6. Recent merger and acquisition transactions in the industry;

and

7. Stockholder information, holding buy/sell or repurchase

agreements.

b. Strategic plans of the company for the projected period.

c. Strengths Weakness Opportunities Threats (SWOT)

analysis; and

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d. Market positioning and company’s view on who they see

as competitors, industry landscape, market size and market

share.

ii. Quantitative aspects:

a. Audited or unaudited historical financial statements (Profit

& loss accounts, Balance sheets, Cash flow statements

along with all schedules) for at least 5-4 years and the

annual reports prepared for the same purpose (including

Directors’ report, Management discussions and analysis,

auditors’ reports and all other associated sections of the

report).

b. Latest unaudited financial statements for the period

closest to the Valuation Date;

c. Quarterly MIS data to assess seasonality and to compare

quarterly performance;

d. Detailed projected financial statements (profit and loss

accounts, balance sheets and cash flow statements) along

with underlying schedules showing the drivers for the

projected numbers;

e. Projected capital expansion costs and working capital

requirements.f. If any term sheets, letters of intent,

investment agreements, loan documents, depending on

whether the valuation subject is an equity instrument or a

debt instrument.

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g. Any recent valuation reports for property, plant and

equipment or specific assets that can be relied upon for the

valuation; and

h. Any other specific factor that could be expected to impact

valuation; for example, Industry outlook and competitors’

information.

Example for broad information required within information

requirement list is given in the box below, while a detailed

sample information requirement list can be referred to in

Appendix E

Example: Information checklist for a company operating diagnostic centers

1. Background of the Company – Qualitative information such as goods/services offered

a. A note on the milestones of the company e.g. when established, addition in the service offerings, registration/acquisition of process, any other milestonesb. Brief write-up on the prospective business plans that the company has – Plans for setting up new diagnostic centres, expansion plans, diversification plans (new services or processes), etcc. Strength, Weakness, Opportunity and Threat (SWOT) analysis of the Companyd. Year-wise data on number of diagnostic centres openede. What is the cost for setting up a typical centre? f. How long does it take for a typical centre to become profitable?g. Number of diagnostic centres as at the valuation dateh. A brief write-up on the key intangible assets such as brand, long-term relationship with corporate, suppliers, doctors, etc.

2. Industry Information – Overview of the industry and positioning of Company3. Financial Information – Historical and projected financial statements, key ratios

a. Diagnostic centre wise break up of revenues and EBITDA for the last 3 years.b. Key Performance Indicators for the Company (Diagnostic Centre-wise and Consol) c. Consolidated and standalone audited financials for the past 5 years, Year-To-Date financials with schedules as at the Valuation Date d. Quarterly financials for the last eight quarters. e. Shareholding pattern as at the Valuation Datef. Additional details on the investmentg. Contingent liabilities/assets, surplus assets as at the Valuation Date

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Risk Management2.3

One of the most important things to be taken into consideration at

all stages of an engagement and especially at the planning stage

is to identify, evaluate, mitigating and managing engagement risks.

The key question around risk management is what is the purpose of

valuation report (i.e. for buying out a shareholder, pricing a transaction,

internal management analysis), intended users of valuation report

and the reliance the users place on the valuation report.

The majority data and information used in a typical valuation

engagement is price sensitive and capable of influencing markets.

Not only does the data risk become important but also it is also critical

in assessment and identification of organizational relationships or

personal interests of the members of the engagement team that could

potentially compromise (or appear to compromise) the independent

nature of the valuation.

The foremost goal of risk management in valuation engagements is

to ensure two things:

2.3.1

2.3.2

2.3.3

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i. The valuation engagement does not expose the Valuer/valuation

firm to self-review risk (i.e. does not put the firm in a position of

reviewing its own work). For example, if the firm provides audit/

assurance services or other services related to preparation,

review or certification of financial statements to a company, then

valuing the company or its equity or assets would result in the firm

reviewing its own work; this should not be done since it defies

the principle of independence. Accordingly, the Valuer needs to

check at the very outset of the engagement whether the Engaging

Client or the Valuation Subject is an audit client and whether the

services being rendered are permissible from a firm risk policy

perspective. Similar checks also need to be done for any third

parties that would be involved in the engagement and have access

to the valuation report. and

ii. There is no real bias in arriving at the valuation. This implies

that the value conclusion should be fair, independent and

representative of the true value of the business, equity interest,

asset or similar subject of valuation. This can be done by ensuring

that the valuation firm and all the valuation team members do

not have any conflict of interest in undertaking the valuation.

Disclosure of personal financial interest in the Valuation Subject,

Engaging Client and counter parties is important in addressing

the Valuer’s conflict of interest. In case there is perceived bias, all

information should be disclosed and in case there is a real bias,

the Valuer should not work on the engagement. This subject will

be covered in further details Later on.

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Some of the other aspects related to risk management are risk

classification of engagement, confidentiality terms, third party

risk and limitations of liability, each of which will be covered in the

following section.

In addition to the above factors, the Valuer should also consider

additional risk configurations, which includes the following:

(i) If there is adequate time to conduct the required analysis?;

(ii) If the Valuer has access to the personnel and resources they

need for the valuation?; and

(iii) Does the Valuer have the competencies to value the business

and do they understand the industry?

Risk Classification of an Engagement

2.3.4

2.3.5

2.3.6

2.3.6.1

2.3.6.2

Every prospective engagement should be classified according

to its risk profile as being low, moderate or high risk. A Risk

Management Action Plan (RMAP) should be prepared for every

engagement classified as high risk; such a plan is encouraged for

moderate risk engagements.

Mandatory classification as a high risk engagement should be

done in the following scenarios:

i. Where work is being performed without limitation of liability

(e.g., private comfort in connection with an investment circular

or statutory opinions in connection with financial assistance) or

at a limit in excess of those set out in the firm’s guidance.

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2.3.6.3

ii. Where the engagement involves public reporting in an

investment circular; and

iii. Where there is significant public interest element in the

work (e.g., certain government work).

iv. Valuation for litigation where court relies on opinion in arriving

at a decision. Representation of the client or situation requires

care especially client or situation is known to be litigator.

Engagements may be classified as high risk even in the absence

of any of the above criteria; the Valuer may still decide that

the engagement should be classified as high risk based on a

combination of other factors identified during the engagement

acceptance.

General considerations affecting the risk profile include (the list is

not exhaustive):

i. The size and complexity of the engagement (e.g., use of

cross-border and multi-functional teams).

ii. The client involved (experience, sophistication, history of

client relationship, litigation history of client).

iii. The client’s intended use of our work (e.g., public reporting,

reporting, regulatory compliance).

iv. Any restrictions imposed (e.g., timeline, access to

information, fee).

v. The size of the liability cap.

vi. Whether it is a new service offering.

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vii. The size or type of engagement or transaction.

viii. The public profile of the engagement or the transaction.

ix. Extent of third party involvement/exposure and acceptance

of responsibility to other parties.

x. Significant technical skills required perhaps outside of the

Valuer’s expertise.

xi. Likelihood that the valuation will lead to litigation or some

public scrutiny; and

xii. Likelihood that the client will be unable to pay their fee.

2.3.6.4 The RMAP should cover the following key areas:

i. Definition of the factors identified during the initial planning

phase that contributed to the high-risk classification for the

assignment.

ii. Description of the risk management actions/procedures to be

used in the valuation engagement. Examples of these actions/

procedures might include any of the following.

a. Appointment of an [independent] Risk Management leader

or second engagement leader.

b. Identification of specific technical resource.

c. Use of more senior team members.

d. Additional reviews of work product.

e. Involvement of personnel with specific industry knowledge.

f. Documentation protocols.

g. Management of scope changes; and

h. Fee collection.

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iii. Identification of the team members responsible for those

actions/procedures;

iv. Estimation of the time required for performing the selected

risk management actions/procedures; and

v. Conducting an internal review of the valuation by the firm’s

“review committee” who are independent of those preparing the

valuation.

Identification of conflicts of interest2.3.7

2.3.7.1 A conflict of interest is an existing situation where a Valuer could

potentially benefit from the value conclusion on a particular

engagement, directly or indirectly. A simple instance of this is as

follows.

Consider a situation where, Narweej Limited (NL) is buying majority stake in Abdullah Co. (AC) and Ameena, the Valuer for AC holds shares in NL. In this case, if the transaction is a favorable one, the acquisition may push prices of NL upwards and Ameena would stand to benefit. Further, Ameena may have access to material, price-sensitive information giving her an advantage over other market participants. Since the price at which NL would buy the shares of AC may be influenced by Ameena’s valuation of AC, she is in a position to influence which way the transaction goes and hence, benefit from it. This is an inherent conflict of interest as well as an independence issue since Ameena, who should ideally have only the best interests of her client AC in mind, could in this circumstance, be somewhat biased to her personal interests. While Ameena may be an objective Valuer and keep her personal interests aside of her professional engagements, this actual conflict of interest is sufficient risk to prevent

58

Another situation which presents a conflict of interest is when a Valuer (whether in his/her individual capacity or the firm as a whole) has access to classified information on both sides of a transaction or valuation event. For instance, if Narweej Limited (NL) is contemplating an investment in Abdullah Co (AC) and the Valuer, Juhaina Advisory Services Company (JAS) was to advise both NL as well as AC, there is an inherent conflict of interest. In this case, the engagement team at JAS is automatically forced into a position of prioritizing the interests of one client over another. In another situation, JAS accepts the valuation engagement from AC. While at the time of accepting the engagement, JAS is not representing NL but NL is a long-time client of JAS. Now at the time of taking on the engagement, JAS should anticipate the conflict and decide which client it wants to represent on a particular engagement. Client relationships are very important in the services industry and accordingly, if JAS wants to accept the engagement from NL, it should decline the engagement with AC. AC would need to engage their own objective valuation expert.

2.3.7.2

2.3.7.3

At the very outset of a valuation engagement, it is imperative to

take cognizance of existing and/or potential conflicts of interest

and outline measures to address them appropriately. If required,

the Valuer (or valuation firm) should not engage in the valuation

assignment. However, under no circumstance is it acceptable

for a Valuer (or valuation firm) to be seen as compromising its

independence.

A useful tool to acknowledge this risk is to have the engagement

team disclose, internally all existing and potential conflicts prior to

accepting the valuation engagement so that appropriate decisions

can be taken with regard to staffing the project or even accepting

or denying it in some extreme cases.

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Independence confirmation status2.3.8

2.3.8.1

2.3.8.2

2.3.8.3

The independence confirmation is defined as a statement

confirming independence from conditions and relationships, in

the context of an engagement, would compromise the integrity

or objectivity of the company or person involved. It is important

to disclose all conflicts of interest, clarify and document the

independence of the Valuer when no conflicts exist. This puts the

responsibility on the engaging team to both, disclose conflicts or

declare independence as the case may be, so that the valuing

firm’s interests are protected, and the client is assured that the

valuation team is objective and independent.

Accordingly, these two risk mitigation measures must be

undertaken at the outset of an engagement to prevent conflicts, at

advanced stages of the project.

In many organizations, it is not only the Valuer’s own investments

and financial interests that determine independence but also that

of his/her immediate family (spouse, children, dependent parents

and any other person whose account is directly or indirectly

managed by or beneficial to the Valuer). It is important to be

thorough with the firm’s independence requirements to avoid any

violation of independence.

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2.3.8.4

2.3.8.5

Also as mentioned earlier, if the firm has separate departments

providing various services – such as audit and assurance services,

valuation advisory services, investment and trading services, it is

critical that each of these services are adequately ring-fenced

from each other i.e. the same teams are not responsible for

multiple roles and their independence is not compromised under

any circumstances. Even if the firm provides many services to a

client, the team in each of the services should ideally be separate.

Confidentiality is also applicable to different functions and service

lines within the same firm. Valuation services should not be rendered

to a company whose financials are audited by the same firm (i.e.

the Professional Service Company/ Valuer) and vice versa. Further,

if a client wants valuation done for M&A support on a Target, which

is being audited by the same professional services firm (i.e. the

Valuer), special approvals needs to be obtained from the Target

and the Client’s management; the valuation team cannot ask for

client information directly from the audit team without the Target

and Client’s explicit authorization.

The independence of the Valuer can also be questioned by the

acceptance of gifts, favors and special privileges that the client

does not otherwise offer to its customers (such as a client gifting a

lavish holiday to the Valuer on submission of a favorable valuation

report, or a client regularly sending expensive chocolates and gift

items to the Valuer).

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2.3.8.6

2.3.8.7

2.3.8.8

Another situation in which a conflict or a breach of independence

could arise is when an immediate family member of the Valuer are

employed by the valuation subject or its related entities or counter

parties to the engagement (i.e. in a litigation case, where the

Valuer has a direct interest in the counterpart to the litigator) and

is in a position to benefit from the result of the valuation exercise.

It is important to remember that not only is the existence of conflict

or breach of independence seen as fraud but also the potential

for conflict or perception of bias is enough to raise suspicion of

fraud. Fraud here should not be misconstrued as wrongful criminal

declaration for personal gain and should be considered as the

breach of independence – providing valuation service without

biasness and unfairness.

There are many instances where the independence of Valuers

has been questioned by the regulatory authorities and a robust

paper trail is the only strong evidence that the authorities rely on

to establish that adequate procedures are in place to prevent the

valuing firm and/or its Valuers from inadvertently committing fraud.

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2.3.8.9

2.3.9.1

2.3.9.2

The Valuer or his immediate relatives must not have a financial

interest in entities being valued or client or counter party. This is

to prevent insider trading, as Valuers have access to nonpublic

information. A declaration should be made to confirm that he/she

or immediate relatives do not have any holdings in entity being

valued. If such holdings exist, then the Valuer should excuse

himself from working on such engagement. However, Insider

trading is an illegal practice where investors tend to use the insider

and confidential information of the company and is separate from

breach of independence. The Valuer must follow the necessary

measures to prevent any illegal practices.

As mentioned earlier, Valuers deal with confidential information in

their engagements; information that, if it were known to the public,

would impact the business or owner’s interests.

In using confidential information, the Valuer owes a responsibility

to the client that there are precautions in place to maintain the

confidentiality of information provided by the client. Engagement

agreements and contracts should have a confidentiality clause

that describes the Valuer’s practice on code of confidentiality.

Refer to Appendix F for Independence Confirmation.Refer to Appendix G for Sample Conflict of Check conditions and Sample Internal

approval letter for potential conflict of interest.

2.3.9 Confidentiality

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2.3.9.3

2.3.9.4

Clients may insist on a Non-disclosure Agreement (NDA) to impose

upon the Valuer the importance of maintaining confidentiality.

Some of the rules to follow with regard to maintaining client

confidentiality are listed below:

i. Valuers should ensure workplace security such as

maintaining proper firewall and security on the firm’s server and

computers;

ii. Valuers should use code words for key client entities

involved in the valuation and for the project as a whole;

iii. Valuers should discuss confidential information within

closed meeting rooms or designated project rooms and not in

the common areas in the presence of co-workers or passers-

by;

iv. Confidential information must never be left lying on tables,

loosely in drawers or even flashing on the mobile screen. It may

be better not to have a paper trail of confidential information at

all and have them in soft copies only, preferably in password-

protected form, saved/ stored on the company server and not

on Valuer’s personal/ work computer hard drive and to ensure

to have projects adequately documented;

v. Backups and archives of confidential projects should be

systematically taken and only designated personnel should

have access to these; and

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vi. Valuer should not discuss client information with family and

friends, irrespective of whether the information is confidential

or not. The engagement team should be the only one with

access to the information and sharing with co-workers should

be on need to know basis and on the condition that the co-

workers are appropriately ring-fenced and subject to the same

independence and conflict checks, confidentiality terms and

conditions as agreed by the rest of the team.

Refer to Appendix H for Sample Non-Disclosure Agreement

2.3.10.1 A valuation opinion is time-specific, situation specific and client

specific; the same entity when valued at another time, in another

situation or to another stakeholder may potentially have a different

value. Hence, from a risk management perspective, the Valuer

should make sure that the engagement agreement protects it from

any potential liability and the client is not in a position to:

i. Question the integrity of the firm in providing valuation

advice or the quality of the valuation advice and /or

ii. Provide reliance letter or duty of care to third parties (including

lenders, creditors, agents, etc.), who were not originally party to

the engagement. If the third party relies on a valuation that is not

originally carried out bearing its interests in mind and the third

party makes a decision on that basis, this exposes the valuing

firm to significant risk.

2.3.10 Other matters

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2.3.10.2 It is important to identify at the start of an engagement all the

interested parties to the valuation, asses their role in relation to

the valuation target and define their rights and responsibilities so

that the firm cannot subsequently be made accountable to new

parties. The exception to this rule may be government authorities,

regulatory authorities or any party specifically required by law to

have access to the deliverables of the engagement. Such central

or state-level bodies, regulations and laws may take precedence

over the terms of the engagement contract and supersede any

confidentiality, liability or third-party reliance restrictions.

iii. Generally, the Valuer restricts the distribution of the report

to any third party. However, if the Engaging Client wishes to

share the valuation report with any third party, he/she can share

the report on the basis of release letter or duty of care letter.

Through the release letter or duty of care letter, the Valuer shall

accept to distribute / share the valuation report to the third party

and shall owe no responsibility to the third party (and) shall have

no liability in tort to the third party in relation to the content of

the valuation report. If a duty of care is executed between the

Valuer, Engaging Client and the third party then the Valuer owes

the responsibility to the third party.

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2.3.10.3 Another key factor is a limitation on the liability of the firm. If at all a

situation does arise where the firm or the Valuer is made liable by

the client or third parties, then there must be a cap on the liability

that the firm / Valuer should have to bear. This is essential because

keeping this number uncapped exposes the firm to infinite liabilities.

The limit must be explicitly defined in the engagement contracts

and ideally, capped to the fee on the engagement. Sometimes,

the cap is a multiple of the fee since clients try to cover their risk

as well. However, it is in the Valuer’s best interests to agree to

a cap that is commensurate with the risk, subject to any legal/

markets requirements and moreover, the Valuer should consult a

knowledgeable legal counsel to thoroughly draft the indemnity and

liability cap clauses in the contract.

Planning for the work2.4

2.4.1 An effective plan requires the following:

i. An understanding of the client›s instructions.

ii. The identification of relevant matters from initial meetings with

the client and the subject company. and

iii. Assessment of other available information sources, which are

likely to assist the planning process.

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At the planning stage, the Valuer will have time to conduct only

limited research. However, subject to confidentiality requirements,

the following preliminary research procedures may be considered

at the planning stage:

i. Obtain insights about the engagement or transaction. Relevant

experience could be industry, strategic, specific transactional or

functional (operations, technology, markets), or geographic;

ii. Request the client to provide any information that may be

useful to the initial planning;

iii. Perform a media search; and

iv. Review market or industry reports, brokers› reports and

competitor information.

The preliminary research at the planning stage should built upon

initial research performed to support engagement acceptance.

Additional research may be performed during the course of the

engagement and the key findings should be documented.

The Valuer must consider the below matters at beginning of the

planning stage:

i. Preparing a written plan is not a mandatory requirement

for every engagement. However, it is an effective method of

communicating the planned approach to the engagement team

and serves as a checklist of steps to be performed.

2.4.2

2.4.3

2.4.4

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ii. An RMAP as described previously must be prepared and

documented for all high risk engagements; and

iii. Appropriate documentation should be put in place where

the Valuer needs to sub-contract part or all of the work on a

particular engagement to another department or a different

country practice of the Valuer. The documentation, such as

signed subcontract agreements memo or an interoffice memo

should outline the roles, expectations and responsibilities of the

parties involved.

The extent and detail of a written plan will depend on the size

and complexity of the engagement; for a small and less complex

engagement, the plan might be communicated in a short e-mail to

the engagement team.

Where a written plan is prepared, it may be supplemented by a team

briefing to provide additional information including communicating

project roles and responsibilities to team members and allowing

team discussions and questions to be raised by the engagement

team.

Where a detailed agenda has been prepared to support an

engagement team briefing, this will have some of the characteristics

of a written plan and should be retained on the same basis as a

written plan.

2.4.5

2.4.6

2.4.7

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A written plan may include the following elements:

i. Project background including key findings from the preliminary

research;

ii. Confirmation of the scope of work;

iii. Identification of the engagement team and their respective

roles and responsibilities for each work stream;

iv. Timetable for completing the engagement including key

milestone dates for each work stream;

v. Estimation of time/cost budget for each work stream;

vi. Areas of key risk and sensitivity related to the project; and

vii. Useful administrative information (e.g., client contact details,

engagement team contact details, etc.).

Scope of work:

i. The scope of work should be agreed in writing in an

engagement agreement; Identification of the procedures that we

must perform to meet all the scope of work requirements should

be done at the planning stage; and

ii. The scope of work should be communicated to the Engaging

Client prior to completion of the engagement. The scope of work

should include the following:

a. Identity of the Valuer.

b. Identity of the client(s).

c. Identity of the intended users.

d. Company or interest in company being valued.

2.4.8

2.4.9

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e. Purpose of the valuation;

f. Basis of value used;

g. Valuation Date;

h. The nature and extent of the Valuer’s work and limitations

thereon;

i. The nature and sources of information upon which the Valuer

relies on;

j. Significant assumptions;

k. Type of report being prepared; and

l. Restrictions on use, distribution and publication of the

report.

iii. In some situations, the engagement agreement might be

sufficiently detailed to describe the objectives of our work and

the procedures to be performed. In these instances, a) the

development of an additional approach plan is at the discretion

of the engagement partner and engagement manager; and b)

the engagement manager is required to ensure that all team

members understand the key project assumptions (i.e., basis of

value, valuation date, etc.)

Materiality and risk areas:

i. At the planning stage, the Valuer should identify those

aspects of the work, which are likely to be the most significant due

to their financial magnitude, complexity or inherent uncertainty,

to focus the resources on these areas of the work and should

detail/ document steps to mitigate risks.

2.4.10

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ii. Prioritize those matters which are likely to require detailed

consideration or discussion, over matters which are likely to be

more routine, so that key issues are brought to light earlier and

there is sufficient time to resolve complex matters.

iii. In order to assist the Valuer to form his own view, the Valuer

should discuss the project with the client to establish their

view about which aspects of the work are likely to be the most

challenging or significant.

iv. Where the client consists of more than one separate party,

care should be taken to assess materiality and risk areas taking

account of the needs and interests of every member of the client

group.

v. Determining materiality will vary according to the Valuer’s

views and the nature of the work; and

vi. Ensure adequate skilled and experienced staff are dedicated

to the highest areas of risk.

Work product requirements and timetable:

i. At the planning stage, the Valuer should understand the

manner in which the client expects the Valuer to report the findings

and/or issue the work product (including progress reports on

interim findings and the final reports);

ii. It may be appropriate to prepare outline template reports or

work product at an earlier stage to confirm the client’s requirements

or to assist the Valuer to ensure that we meet all scope of work

requirements; and

2.4.11

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iii. At the planning stage, the Valuer should understand the

anticipated timetable for receiving information required for

completing each stage of the work.

Forming the plan guidance

The engagement partner and engagement manager should

establish a clear understanding of what is required for the valuation

engagement, taking account of the results of preliminary research

and the other matters considered during planning. This planning

process should determine:

i. The nature and timing of work product including timetable for

progress reports on interim findings and the final reports.

ii. The nature and timing processes and procedures that will be

perform (and the staff resources required to undertake these

activities).

iii. The nature and timing of information to be provided by the

client or third parties.

iv. A budget estimate for costs; and

v. Assigning experts and valuation professionals to be involved

in the project.

Often the planning process will break the overall engagement into

a number of separate (but relates) work streams and may include

verification by senior professionals and/or review committee. The

planned approach should be communicated to all team members

so that they understand the context of the work as well as the

significance of the findings.

2.4.12

2.4.13

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Scope of work and timeline2.5

Scope of work2.5.1

2.5.1.1 The ‘Scope of work’ refers to a documented understanding between

the Valuer and the client regarding the basic terms of the valuation

engagement. As per the International Valuation Standards (IVS),

2017, the scope of work covers broadly the following aspects:

i. Identity of the Valuer.

ii. Identity of the Client.

iii. The business, assets or financial interest that is being

valued and the basis for the same.

iv. The purpose and end-use of the valuation along with

restrictions on its circulation, reliance and third-party use, as

applicable.

v. The Valuation Date.

vi. The nature, extent and sources of information that would

be made available to the Valuer for the purpose of the

valuation exercise.

vii. The extent of Valuer’s work as well as clearly defined

limitations to the scope of work.

viii. Any specific assumptions pertaining to the subject of

valuation that need to be taken into consideration by the

Valuer.

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2.5.1.2

ix. The report that is expected from the engagement, including

the format in which it would be prepared and the manner in

which it will be communicated and restrictions to be used in

addition to the distribution and publication of the report; and

x. Reference to any regulatory or accounting standards,

guidelines or rules that apply to the valuation exercise and

confirmation that the valuation would comply with such

stipulated guidelines.

The following section examines each of the above ten points in

detail.

i. Identity of the Valuer

The scope should identify if the Valuer is an individual, group

of individuals or a firm and whether the Valuer has any material

interest in the Valuation Subject. Also, the scope should highlight

if there are any other factors that could limit the Valuer’s ability to

provide an unbiased and objective valuation.

ii. Identity of the Client

The scope should identify the Client(s) for whom the valuation

is being produced. It is important to determine the form and the

content of the report to ensure that the information in the report

is relevant to the Client(s)’ needs.

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iii. The business, assets or financial interest that is being

valued and the basis for the same

The scope should identify the subject of the valuation explicitly

and indicate whether there are any specific exclusions or

inclusions to the same. It should also indicate the basis for

the valuation, which shall include the following:

a. Whether it is based on audited or unaudited financial statements of the company; b. What is the date of the financial statements that the valuation would be based on; and c. Whether the valuation would be at an enterprise level or equity level and whether there are any additional documents that form the basis for the valuation (e.g. term sheets or investment agreements for valuation of structured instruments).

iv. The purpose and end-use of the valuation along with

restrictions on its circulation, reliance and third-party use, as

applicable

a. The scope should indicate the intended end-use of the valuation, which is based on the purpose of valuation as discussed with the client; andb. The scope should clearly mention what the valuation can be used for as well as the restrictions on its use – for example, it should clearly state that the valuation cannot be shared with any third parties without the prior written permission of the Valuer. If there are specific third parties that would need access to the valuation report and these parties are known at the time of entering into the engagement, it is usually recommended that they are parties to the engagement as well. Alternatively, they can be provided access to the valuation upon signing a release letter (for access on non-reliance basis) or a duty of care letter (on reliance basis with full responsibility of Valuer to the third party) or a hold harmless letter (on reliance basis but with restricted rights and obligations of the third party) as the case may be. It is important to consult with the firm’s Quality and Risk Management (Q&RM) personnel and seek necessary approvals and guidance on the right approach to follow in each case to minimize risk to the firm.

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v. The Valuation Date i.e. the reference date as at which the

valuation is required

a. The Valuation Date is a cut-off date on which the business enterprise is officially appraised or priced; andb. Documenting the Valuation Date in the scope is necessary since valuation is time-specific and valuation for the same subject could be different if undertaken at a different point in time; emphasizing on the Valuation Date also points to the relevance of the valuation in relation to its purpose.

vi. The nature, extent and sources of information that would be

made available to the Valuer for the purpose of the valuation

exercise

a. It is advisable to include the information required and agreed to be provided by the client for the valuation;b. At this point, it is important either to emphasize that the valuation would be based on information to be provided by the client and that the Valuer would rely on the information and accuracy of the information provided by the client and not be responsible for the accuracy of information that is provided by the client or incorrectly provided. This puts the responsibility of ensuring integrity of data supplied for the valuation exercise on the client; andc. It should be explicitly documented if the lack of availability of any data would impose limitations on the valuation process or require any special adjustments or assumptions to be made in relation to the exercise. For example, at the outset of the engagement, if it is known that the company would not be in a position to provide a business plan, the same should be mentioned clearly to support the valuation methodology used and potential limitation to be reported on.

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vii. The extent of Valuer’s work as well as clearly defined

limitations to the scope of work

a. The procedures that would be performed by the Valuer should be outlined under the scope. If there are additional service elements that are required by the client (such as business plan validation, scenario analysis or valuations at multiple Valuation Dates or any other special requirements), these need to be specifically mentioned in the scope and factored into any negotiations around timelines and fees as well; andb. The Valuer may provide some additional services including valuation reviews or fairness opinion for the valuation performed by the management of the Client. In addition to these services, the Valuer may conduct training services on valuation for other institutions/group. c. These additional services would typically be subject to a separate engagement letter and not be part of the valuation engagement. However, if the Client wants to execute any proposed services together, Valuer can execute a single engagement letter highlighting and defining separate scope of work, fees and terms & conditions for each of the proposed service.d. The scope of the fairness opinion engagements includes providing fairness report for the valuation performed by the management of the Client as at a particular Valuation Date. Fairness report should include the observations on the valuation performed by the management of the Client, procedures that Valuer performed to check the fairness of the valuation and conclusion if the valuation carried out seems fair from the valuation purpose perspective. e. While it is important to outline the Valuer’s responsibility, it is also essential to indicate the exclusions from the scope of work in addition to caveats, limitations, terms and conditions that would govern the overall execution of the engagement. Some of the typical exclusions that Valuer should consider indicating to their clients are listed below:

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1. Provision of accounting, tax, regulatory or legal advice in relation to the valuation subject, proposed transaction or potential strategic action that may be taken on the basis of the valuation;2. Reviewing or validating the financial statements and MIS information provided by the client;3. Preparing a business plan for the valuation subject (this could result in a conflict since the business plan prepared by the Valuer would inherently incorporate the Valuer’s bias in the forecasts and jeopardize the independence of the valuation opinion to be provided). Forecasts typically are prepared by Client. The Valuer can assist in preparing of forecasts and reviewing them but ultimately Client is responsible for the assumptions. However, the Valuer should review the business plan provided by the client based on a broad comparison with historically achieved performance and industry trends. Accordingly, business plan validation may be permissible, but business plan preparation should be kept out of the scope unless the engagement team responsible for preparation of the business plan is entirely different from the team responsible for undertaking the valuation;4. Perform due diligence or undertake valuation of individual assets (unless otherwise agreed as part of the scope); and5. Evaluate technical/operational capacities and performance of the client’s business, products or services, which are outside the domain of expertise of the Valuer.6. The Valuer should address the Valuer’s right and obligation to review and revise all valuation analysis and update the valuation report in light of facts existing at the Valuation Date which become known subsequent to the date of the report. If the Valuer misses out some information in the valuation analysis, it is the obligation of the Valuer to update the report after informing the Client. However, if the Client withholds some information, it will be the Valuer is right but not obligation to update the report. If there are some subsequent events post Valuation Date that would affect the valuation analysis, a separate engagement is required for the same.

f. The above is an indicative list of exclusions that Valuers should consider incorporating as part of the scope document and communicates to clients so that there is no ambiguity around what the Valuer will and will not do.

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viii. Any specific assumptions pertaining to the subject of

valuation that need to be borne in mind by the Valuer.

a. Sometimes, at the time of entering into a valuation engagement, it is necessary to make certain assumptions around the valuation subject. For example, when valuing a company with various divisions or segments, certain items such as fixed assets or corporate overheads may not be explicitly allocated to the divisions in the business plan. If these divisions are required to be valued separately (and not on a consolidated basis), then the client would need to provide a basis for the allocation which may not actually be incorporated in the business plan. Such assumptions should be clearly documented in the scope, as depicted in the following example.

ix. The deliverable that is expected from the engagement, including

the format in which it would be prepared and the manner in which

it will be communicated

a. The scope of work should clearly indicate the final deliverable on the engagement that is expected from the Valuer. It should also mention the format in which the deliverable would be prepared and the manner in which it is to be shared with the client;

Example:

“We have been engaged to value Akbar Company Limited (ACL) as at 31 December 2017 (Valuation Date) based on the financial statements for ACL as at the Valuation Date. We understand that we would be provided with historical financial information for ACL for 4 years and forecast financial statements for 5 years from the Valuation Date. ACL operates in four business divisions, namely – manufacturing of garments; trading of accessories, bags and shoes; operation of retail stores; and provision of boutique tailoring services. We understand that the forecast financial statements have been prepared on a consolidated basis for ACL as a whole. Divisional profit & loss statements for the specified historical and forecast period have been prepared; however, the allocation of common assets and costs were not been carried out. The basis for this allocation as required for the valuation

would be provided to us by ACL.”

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b. Typically, the deliverable on a business valuation engagement is a report on the valuation of the subject as at the Valuation Date. It should be indicated whether the report will be shared in hard or soft copy format, or both;c. Usually, the valuation calculations and Excel work products are the working papers and intellectual property of the Valuer. These are not shared with the client unless otherwise agreed. Accordingly, it is better to mention that the editable files prepared by the Valuer to arrive at the valuation will not be shared with the client; andd. Another important detail to be mentioned here is the issuance of draft and final versions. It is always advisable to issue draft versions to the client before finalizing the reports. This is so that the client is provided an opportunity to seek clarifications and confirm any factual details regarding the valuation subject prior to finalization. Ideally, the client should be provided a specified period such as 10 business days or 3 weeks to revert with comments or queries on the draft deliverable following which, if there are no observations, the Valuer may proceed to finalize the deliverable. The Valuer should have control over the draft copies. However, draft reports can be destroyed once final valuation report is issued and finalized.

x. Reference to any regulatory or accounting standards, guidelines

or rules that apply to the valuation exercise and confirmation that

the valuation would comply with such stipulated guidelines

a. If there are any regulatory guidelines, accounting standards or other rules that apply to the valuation, these should be clearly identified in the scope of work so that the approach and limitations are clear to the client and the Valuer.b. For example, purchase price allocations are prepared following an acquisition as per IFRS 3 when a company acquires another business. It is therefore, advisable to mention as part of the scope that the purpose of valuation is to comply with this standard;c. Similarly, regulators may issue notices, circulars or guidelines to govern when valuations are required and if any specific approach is to be followed. Reference should be made to such circulars or notices to identify the basis that would be followed for the valuation; andd. In addition to all the above parameters, any special feature applicable to the valuation known at the time of entering into the engagement should also form part of the scope document. Hence, the scope of work document becomes the starting point for documenting all engagement administration and execution.

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Timelines2.5.2

2.5.2.1

2.5.2.2

2.5.2.3

Once the scope of work has been clearly outlined, the next

engagement parameter to agree upon is the timeline. This can be

very challenging since valuation is perceived by many people to

be somewhat formulaic and the time, efforts and analysis that go

into arriving at a robust valuation are often underestimated.

It is important to set timelines that are realistic, achievable and

commensurate with the extent of work involved. For this purpose,

preparing a work-plan is always a good place to start. This involves

identifying workflow streams and activities, assigning team

members and resources who will be responsible for preparing the

work, estimating time required for each activity, setting milestones

and providing for delays at each level.

In estimating the time required, the Valuer should consider

the skills, expertise and number of people to be engaged in a

particular activity since the time estimate should represent total

‘man-hours’. For example, if the activity under consideration

is ‘peer-group analyses with 3 people engaged on it with each

expected to devote 8 hours, the total effort estimate for this activity

is 24 man-hours.

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2.5.2.4

2.5.2.5

2.5.2.6

2.5.2.7

It is also important to note that the timeframe required to carry out

a valuation of the Valuation Subject depends on the complexity,

level of detail, extent of information available and the availability of

management of the company. For example, research and analysis

for a public limited company would /may take less time than a

private limited company as most essential information would be

readily available. Therefore, the timeline is not a template and

needs to be customized on a case-by-case basis.

Once the total hours required have been estimated, the timeline

should be discussed and agreed upon.

If required, the timeline can be shortened by resourcing additional

team members on the engagement; however, this would be

subject to their availability and level of experience.

Depending on the client’s requirements regarding the timeline,

the Valuer may choose to have more senior, mid-level or junior

team members on the engagement as there is a trade-off between

the skills and experience vs. cost of deploying more senior team

members.

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Calculation of fees2.6While there is no standard approach for the calculation of fees, the

final fees agreed between the Valuer and the client shall be based

on various rounds of discussions and negotiations. The starting

point for the negotiations is based on an effort estimate, a billing

rate, an expected margin and pricing benchmarks (both, for similar

engagements with other clients and past engagements with the

same client).

Once the approximate effort required on the engagement is

estimated, the work needs to be allocated to various levels since the

billing rate for a junior team member would be quite lower from that

of a senior member. Alternatively, an average rate may be applied

that captures adequately the mix of team members at various levels.

2.6.1

2.6.2

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The billing rate could either be a straightforward rate which includes the

margin or broken up into the cost component and margin component.

Often, engagements are won on competitive bids where the lowest

bidder or the Valuer with the lowest fee quote wins the engagement. In

such cases, for a Valuer to be successful in winning the engagement,

the Valuer should ensure that proposed fees is sufficient to complete

the work with an adequate margin for the efforts expended. The price

quote must be realistic and commensurate with the scope of work

agreed, yet factor some degree of efficiency in order to highlight the

Valuer’s competitive edge. The estimation of efforts and fees should

consider realistic timelines without compromising on quality.

An alternate fee arrangement is the ‘fixed plus success fee’ mechanism,

which is often used in the case of providing services for transactions.

In such cases, the initial fixed fee is just sufficient to cover cost and

the margin or upside is earned, when the transaction is executed.

While valuation professionals may not prefer this arrangement given

the risk of transaction closure and the time that a deal takes from

initiation to closure; however, these pricing arrangements can have

significant upside if the transaction is successful. However, these

success fee arrangements are inherently biased and discouraged

due to the conflict of interest the Valuer will have in a successful

transaction. The Valuer should not encourage a success fee based

mechanism as a form of contingent fee is perceived to impair the

Valuer’s independence.

2.6.3

2.6.4

2.6.5

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Billing of fees should be milestone-based rather than on engagement

completion, some of which shall be charged in advance.

The fee proposal should also clarify who will bear any incidental

and out-of-pocket expenses – whether these would be borne by

the Valuer, by the client or reimbursed by the client. Details of any

applicable taxes/zakat, charges, and levies must also be clearly

outlined so the client is aware of the all-inclusive fee quote.

2.6.6

2.6.7

Proposal2.7Proposals are initiated by the client; they are generally required as

part of a process to award valuation engagements, usually under

competitive bidding;

Proposals are prepared in response to a requirement;

Proposals may sometimes have a prescribed format that all bidding

Valuers need to follow; and

Under Proposals, the client usually dictates the key terms of the

engagement (once it is won) with little or no flexibility afforded to the

Valuer to customize the same.

2.7.1

2.7.2

2.7.3

2.7.4

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The process of competitive bidding for valuation of a business or

project may start with a Request for Proposal (“RFP”). Government

agencies or contracting companies invite Valuers to put forth their

proposal for valuation subsequent to which a Valuer is finalized and

selected. The RFP usually requires submission of the following:

i. A letter of intent which communicates the Valuer’s intention or

interest in providing the required services; and

ii. Technical and financial proposals as part of the bidding process.

2.7.5

2.7.5.1 Technical Proposal

i. The technical proposal outlines and expounds on the

technical competencies that the team possesses, which

highlights how the Valuer a competent candidate for the

valuation.

ii. The technical proposal shall include the following:

a. A scope document or a process note that outlines the key

steps that the Valuer will perform as part of the valuation, key

inclusions and exclusions and the deliverables under the

engagement.

b. A professional résumé of the engagement team members

highlighting their educational background, qualifications,

experience and proposed role in the engagement; and

c. Information on recent and past credentials and case studies

of successful engagements (and references upon request).

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2.7.5.2 Financial Proposal

i. The financial proposal includes break-up between staff

level, time and cost;

ii. If the engagement is comprised of various activities, the

financial proposal may require a separate pricing for each

activity. In some cases, the client may decide to award parts

of an engagement to various Valuers depending on technical

competency and time constraints;

iii. The financial proposal would need to outline the following:

a. Billing plan with various milestones defined clearly, if the

RFP does not already specify the same; and

b. The mechanism for incurrence and reimbursement (if

applicable) of any incidental and out-of-pocket expenses on

the engagement, all applicable taxes/zakat and rates and any

other charges that the client would be liable to pay.

A proposal would comprise all the elements described above.

However, they may not need to be prepared and submitted

separately or to follow a standard format. The Valuer may prepare

one comprehensive proposal which comprises all the following

details:

i. Value proposition highlighting industry expertise;

ii. Technical competency;

iii. Proposed scope of services;

iv. Key deliverables;

2.7.6

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2.8

v. Steps to be performed and valuation process to be followed;

vi. Team highlights – experience and key skills;

vii. Past credentials and case studies; and

viii. Fee proposal.

While the above details represent a broad structure for an autonomous

proposal, there is no standard format or template for a proposal as

it is a marketing document and each organization has customized

documents prepared based on internal branding and marketing

conventions.

2.7.7

Engagement Letter

Introduction2.8.1

2.8.1.1

2.8.1.2

The engagement letter is a formal agreement between the client

and the Valuer, which should be signed by both parties before the

formal commencement of engagement.

It states the terms and conditions of engagement, mainly focusing

on scope of engagement, client information, timing, Valuation

Date, etc. compensation estimates to the Valuer for the services

performed and the responsibilities and obligations of each of the

parties involved.

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2.8.1.3

2.8.2.1

The letter of engagement shall define all the terms and conditions, to

avoid any misunderstandings, which may lead to legal/operational/

financial disputes later during the course of engagement

The contents in a standard engagement letter include:

i. Addressee: The letter is typically addressed to client/senior

management member of client firm.

ii. Service to be rendered: This describes the nature of service

to be rendered (i.e. valuation).

iii. Purpose: Stating the purpose why the client needs the

valuation. It also includes the purpose of valuation (i.e. valuation

for acquisition, valuation for impairment testing).

iv. Background: A brief description of the entity/subject to be

valued and relationship to the client.

v. Scope of work: This lays down specifications of work to be

performed by Valuer in regard to the engagement. It would

also include the basis on which valuation will be performed

vi. Basis of valuation: This lays down the basis of valuation

appropriate for the purpose of the valuation and defines what

value implies in terms of the specific engagement;

vii. Limitation of scope: Any limitations or restrictions on the

inspection, enquiry and analysis of the valuation must be

identified. This helps ensure that there is no ambiguity later,

during or post the engagement about both work undertaken

and not undertaken.

Contents2.8.2

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viii. Circulation of report: This states the parties to which the

valuation report would be circulated without the Valuer’s

permission and consent.

ix. Deadlines/Timeline: This section states the estimated date

of completion and release of draft and final reports. The section

also states limitations upon completion being contingent to

release of data from client’s side.

x. Responsibilities of Valuer: This lays out the responsibility of

the Valuer to provide the valuation, to the best of his abilities.

It limits the scope of accuracy of valuation contingent to

accuracy of data and proper representation of factors relevant

to valuation (i.e. which may affect the value). For instance, any

information becomes available after the Valuer has issued the

report, the Valuer may choose to update the report based on

the new information.

xi. Fees: This section lays out the agreed compensation

between the client and the Valuer. This will include any additional

expenses and applicable taxes, which have to be covered by

client and the terms and conditions related to the same. It may

also state terms, schedule and method of payment;

xii. Responsibilities of Valuer: This lays out responsibility of

Valuer to their clients to ensure reasonable skill, care and

delivery in a timely manner.

xiii. Responsibilities of Client: This lays out responsibility of

client to ensure timely delivery of information and timely access

to management personnel assistance and ensure its accuracy.

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xiv. Presentation of results: This lays out the medium through

which Valuer would deliver its valuation report and the broad

contents of the report;

xv. Limitations on usage/Confidentiality: This lays out that

the report/results of valuation may not be disclosed by client to

external third parties, apart from use for intended purpose or

where permission has been given in writing by the Valuer;

xvi. Limitations on liability: This lays out restrictions on liabilities

to be paid by Valuer to client or third parties due to legal

disputes arising out of the engagement. It also limits the value

of liability to be paid, as well as the period for which liability

exists. Limitations on liability section need to specify the client

indemnity provisions related to the engagement in case the

Valuer is drawn into legal disputes; and

xvii. Governing law/Dispute resolution: This lays out the

mechanism for resolution of any dispute, which may arise

between the client and the Valuer. In case of judicial recourse,

it states the laws and the judiciary under which the case shall

be resolved.

Refer to Appendix I for Sample Engagement Letter

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Consortium Agreement 2.9

Sometimes, the valuation services are provided by the Valuer, as part

of a consortium to the client.

The agreement between the consortium and the client should meet the

minimum standards for engagement letters defined in the applicable

policy and in particular contain the following provisions. The level

of risk that each consortium member would be willing to take is a

management/strategic decision that the licensed Valuer should take.

Hence, the engagement agreement shall include provisions around

the indemnity and risks associated with consortium arrangement,

when applicable and such provisions shall be included based on the

legal counsel’s advice.

i. Scope and work products: The scope of services and the work

products should be defined for every Consortium member.

ii. Fees: The agreement should define what share of the total

fees each Consortium member is entitled to as well as the

timings and the other terms of payment.

iii. Liability limitation: The agreement should contain limits on

the liability of the Consortium members. If possible, Valuer

should avoid joint and several liability, in particular where Valuer

does not have the expertise to supervise the other Consortium

members’ work.

2.9.1

2.9.2

93

iv. Sole recourse: To the extent the member firm of Valuer

incurs liability under the Consortium arrangement, the client

should agree to bring claims arising out of the services

performed only against the member firm of Valuer that is part

of the Consortium and acknowledge that there is no agency

relationship between such member firm of Valuer and any

other Valuer entity;

v. Notification of termination/exclusion: In case the remedies

described below, i.e., termination of the Consortium or exclusion

of a member, are exercised, there should be a procedure for

notifying the client;

vi. Governing law and jurisdiction: Particularly in case of a

cross border consortium, the laws of the contracting Valuer

member firm’s country should govern. The courts of that

country should have exclusive jurisdiction or, alternatively, the

Valuer’s member firm may prefer to employ alternative dispute

resolution procedures;

vii. The agreement between the Consortium members should

contain the following provisions:

a. Subject matter and purpose: The subject matter and

the purpose of the Consortium need to be precisely defined.

b. Scope, work product and timing: Both the scope of

services and the work product as well as the timetable for

delivery for every Consortium member need to be defined.

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c. Cooperation: Consortium members agree to provide

each other with the data, information and/or documents

required for each of them to meet their obligations to the

client in a timely manner, including notification of any

delay in performance or of any event that may impact the

engagement.

d. Remedies for the event of a breach of contract by a

Consortium member, e.g., exclusion from the Consortium

and liability to pay increased costs, should also be included;

e. Lead firm: It needs to be agreed whether one Consortium

member should represent the Consortium as the lead

member and what authority the lead member has, e.g.,

whether it is authorized to represent the other Consortium

members or whether it only manages and coordinates the

Consortium.

f. Quality: Consortium members should agree to provide

services with professional care. For quality assurance

purposes, the Valuer should be granted access to work

papers, deliverables and other documents to ensure the

quality and consistency in the deliverables;

g. Decision making: It needs to be agreed whether internal

decisions of the Consortium need to be made unanimously

or by a majority.

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h. IP covenant: It needs to be acknowledged that there shall

be no transfer of pre-existing intellectual property rights

between the members of the Consortium. Consideration

needs to be given as to who will own IP rights created

during the course of the engagement;

i. Payment terms: Consortium members must agree on

specific fee and billing arrangements. Billing can be made

by each member separately or by the lead member;

j. Indemnity: Each Consortium member should indemnify

the other members against any physical injury and any

other losses, damages or liabilities, including a liability to

the client under a joint and several liability obligation, which

arises out of indemnifying Consortium member’s acts or

omissions in connection with the engagement;

k. Confidentiality: Consortium members agree not to

disclose confidential information of the client or other

Consortium members and Circulation or use of report

among Consortium members.

l. No agent/no partnership: Consortium members are

independent contractors and not agents of one another;

m. Independence: The Consortium member represents

that amounts expected to be earned under the business

relationship shall not exceed %5 of the Consortium

member’s total annual revenues.

n. Exclusivity / non-compete provision: Including an

exclusivity/non-compete provision should be considered.

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o. Termination: Reasons for immediate termination by

consortium member need to be defined, including any

consortium member’s bankruptcy, change in independence

status of a consortium member or inability to perform;

p. Also, an end date and or trigger event for ending the

consortium agreement should be defined; and

q. Governing law and jurisdiction: Particularly in case of a

cross border consortium, the laws of the Valuer member

firm’s country should govern. The courts of that country

should have exclusive jurisdiction or, alternatively, the

member firm may prefer dispute resolution by arbitration.

r. Insurance: Identify how the insurance for the Consortium

will be put in place and who will be managing the insurance

related activities.

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Engagement Execution

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Introduction

Valuation Process

3.1

3.2

The engagement execution section defines the fundamental steps

that a Valuer should undertake during the valuation engagement.

However, it should be noted that it does not serve or intend to be a

comprehensive guide on valuation theory. Instead, our objective is

to guide Valuers, as well as the relevant stakeholders (e.g. lawyers,

accountants, business owners, users, etc.) to get an understanding

of the fundamental methodologies, and procedures that should be

followed in the valuation engagement.

For any valuation engagement, the Valuer should perform the

following:

3.1.1

3.2.1

3.2.1.1

3.2.1.2

Define the engagement which includes understanding purpose of

valuation, valuation subject being valued, Valuation Date, basis of

valuation, etc.

Collect qualitative and quantitative information about the Valuation

Subject and the market it operates in;

Analyze information in relation to the following:

i. Valuation Subject

ii. Economic environment, which includes economic and

industry growth, risk free rate, interest rates and market risk

premium.

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3.2.1.3

iii. Market the Valuation Subject operates in, which includes

market size, outlook, historical growth rate, outlook, competitive

tension, key risks, etc.

iv. Historical and prospective financial performance

v. Identify excess assets owned by the business and ensure

that it is not to be separated from the valuation analysis.

vi. Analyze competitors and their performance in relation to

Valuation Subject.

Develop a valuation conclusion through undertaking the following:

i. Selecting the appropriate valuation approach and

methodology. The valuation approaches and methodologies

shall be explained in further details under section 3.8.

ii. Carrying out the valuation analysis using one or two of the

three applicable approaches and performing a reasonability

of sanity check through the use of a secondary approach to

carry out the valuation.

iii. Considering any limitations or defined procedures by

regulators (i.e. for litigation, the fair value does not consider

a minority discount or discount for lack of control for minority

interest). and

iv. Conducting reasonability checks on the analysis and

conclusion.

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3.2.1.4

3.2.1.5

v. Identify excess assets owned by the business and ensure

that it is not to be separated from the valuation analysis.

vi. Analyze competitors and their performance in relation to

Valuation Subject.

Develop a valuation conclusion through undertaking the following:

i. Selecting the appropriate valuation approach and

methodology. The valuation approaches and methodologies

shall be explained in further details under section 3.8;

ii. Carrying out the valuation analysis using one or two of the

three applicable approaches and performing a reasonability of

sanity check through the use of a secondary approach to carry

out the valuation;

iii. Considering any limitations or defined procedures by

regulators (i.e. for litigation, the fair value does not consider

a minority discount or discount for lack of control for minority

interest); and

iv. Conducting reasonability checks on the analysis and

conclusion.

Prepare the valuation report.

i. The general requirements of the report clearly detail the

purpose of the valuation, company being valued, intended

users, scope of the valuation, the work / analysis performed

and the valuation conclusion;

ii. The format of the report should be agreed as part of the

scope of work. and

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iii. IVS 103 describes different reporting types including

comprehensive narrative reports, and abbreviated summary

reports.

Engagement Definition 3.3Confirming the engagement scope with the Client would help

the Valuer in evaluating the various valuation approaches and

methodologies that can be considered for valuing the interest of

Valuation Subject. In this respect, the Valuer should identify the

following:

i. Nature of valuation subject;

ii. Scope and purpose of valuation;

iii. Valuation Date;

iv. Applicable regulations and accounting standards;

v. Percentage of interest of valuation subject being valued;

vi. Applicable basis of valuation that includes standard of value

and premise of value;

vii. Intended use and users of valuation; and

viii. Assumptions and limiting conditions.

The aforementioned information should be established in the Valuer’s

engagement letter prior of executing the engagement

3.3.1

3.3.2

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Data Collection3.4

Valuation involves an initial process of collecting and analyzing

information. Accordingly, during the commencement of the

engagement (preferably in the beginning), the Valuer should seek

to obtain the relevant information to get a good understanding of the

Valuation Subject and the market dynamics around it.

The following is a non-exhaustive list of information the Valuer should

obtain to carry out the required analysis.

i. Qualitative background information, which mainly includes the

Valuation Subject’s background, ownership structure, details

on products/ services offered, SWOT analysis of the company,

discussion on past performance and future trends/prospects of the

company.

ii. Audited or unaudited financial statements, annual reports, and

quarterly management accounts (preferably for the past three to

five years) as well as detailed Information on intangible assets and

on surplus assets/ contingent assets and liabilities, fixed assets

register as at the Valuation Date.

iii. Business plan including prospective financial information and

key assumptions.

iv. Key Agreements such as Share/business purchase agreements,

franchise agreements, etc.

v. Other information including independent reports on the company

or the industry; and

vi. Balance sheet at the Valuation Date.

Valuation involves an initial process of collecting and analyzing

information. Accordingly, during the commencement of the

engagement (preferably in the beginning), the Valuer should seek

to obtain the relevant information to get a good understanding of the

Valuation Subject and the market dynamics around it.

The following is a non-exhaustive list of information the Valuer should

obtain to carry out the required analysis.

i. Qualitative background information, which mainly includes the

Valuation Subject’s background, ownership structure, details

on products/ services offered, SWOT analysis of the company,

discussion on past performance and future trends/prospects of the

company.

ii. Audited or unaudited financial statements, annual reports, and

quarterly management accounts (preferably for the past three to

five years) as well as detailed Information on intangible assets and

on surplus assets/ contingent assets and liabilities, fixed assets

register as at the Valuation Date.

iii. Business plan including prospective financial information and

key assumptions.

iv. Key Agreements such as Share/business purchase agreements,

franchise agreements, etc.

v. Other information including independent reports on the company

or the industry; and

vi. Balance sheet at the Valuation Date.

3.4.13.4.1

3.4.2

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During the execution phase, if the Client is unable to provide any of

the information requested, the Valuer should assess the criticality of

the outstanding data for the valuation analysis and conclusion and

proceed accordingly. For example, in the absence of audited balance

sheet as at the Valuation Date, the Valuer can assume the analysis

based on the provisional statements or management accounts.

However, the appropriate measures to verify the information and

caveats shall be included in the report.

3.4.1

Refer to Appendix E for comprehensive list of requisite information for business valuation.

Calculation of fees3.5

During this phase, the Valuer should analyze the following:

i. The Company’s key historical development, including the

date of which the Company was incorporated, legal structure,

organization structure, shareholders, management, etc.;

ii. Current operations of the Company including products and

services, key suppliers and customers, markets it operates in and

supply chain, number of employees;

iii. The Valuation Subject’s overall operations and business plan;

and

iv. The Valuation Subject’s historical performance in relation to

the competitors.

3.5.1

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Analysis of the business environment

Historical Financial Analysis

3.6

3.7

The Valuer should analyze the size, growth rate, and key market

participants’ dynamics of the market, which the Valuation Subject is

operating in. This includes analyzing the following:

i. Current and expected near-state of the economy and industry;

ii. Key supply and demand characteristics, historical and

projected trends, main drivers/trends underpinning market growth

in the product categories; and

iii. Markets competitive intensity and critical success factors.

The analysis should be based on information available in market

research databases (i.e. Bloomberg, Capital IQ, Capitaline, Thomson

Reuters, etc.) and public domain. In the absence of such information,

a primary research may be undertaken to gather as much market

data. However, the Valuer would work with information he/she knows.

To develop a conclusion about the Company’s future prospects,

the Valuer is required to carry out a comprehensive analysis of the

Valuation Subject’s financial statements covering an agreed upon

historical period (preferably from 5-3 five years). The historical

financial information analysis should include analyzing the following:

i. Revenues, operating costs, financing and other key accounts

relating to the historical period.

3.6.1

3.7.1

3.6.2

107

ii. Return analysis, which includes liquidity analysis, coverage

ratios, and operating ratios (i.e. turnover statistics, expense to

revenue ratios, etc.) For further details, refer to Appendix 6.5;

iii. Historical trends expected to continue in the short to medium

term and calculating key performance metrics which include

revenue growth, profitability margins, return on assets, dividend

ratio, return on capital employed, return on equity, net debt and

EBITDA.

iv. Balance sheet at both the latest available date and the latest

audited position including long-term investments and subsidiaries,

contingent and off-balance sheet assets or liabilities to assess

potential areas of subjectivity and whether there has been any

potential overstatement of assets or understatement of liabilities.

Identification of excess assets and moreover, whether capital

expenses are normal or expansionary.

v. Capital expenditure incurred during the historical period and

whether capital expenditures are allocated for maintenance or

expansion plans;

vi. Historical trends in free cash flow generated by the Company

to identify and understand the underlying drivers.

vii. Cash conversion rate and working capital requirements

during the historical period; and

viii. Consider whether normalization adjustments to historical

figures are necessarily from a market participant’s or a listed third-

party perspective.

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3.7.1.1 Common methods of historical financial information analysis

include the following:

i. Common-size analysis displays line items in financial

statements as a percentage of one selected or common figure.

On the income statement, each line item is expressed as a

percentage of sales, and, on the balance sheet each line item

is expressed as a percentage of total assets. Using common-

size analysis helps investors to identify large or drastic changes

in a firm’s financials.

ii. Trend-analysis analysis compares with historical financial

statements, on an annual and quarterly basis. The Valuer

should look for variations in sales growth, gross margin, EBITDA

margin and earnings.

iii. Financial ratios analysis, which typically covers five major

categories; namely, profitability ratios, liquidity ratios, activity

ratios and leverage ratios and Du Pont Formula.

iv. Comparative Financial Analysis compare the Valuation

Subject’s financial performance against different companies in

the same industry, to get an idea on comparative performance

and valuation.

Refer to Appendix J for Key Financial ratios

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3.7.1.2 During the analysis, the Valuer should adjust the earnings for

non-arm length transaction, unusual or non-recurring transactions

and/or for the effect of non-operating/redundant assets, where

appropriate. The following is a non-exhaustive list of types of

adjustments that may be applied to the historical financial statement:

i. Non-arm’s length transactions which may be at above or

below market values;

ii. One-offs / non-recurring items including one off income,

costs and expenses;

iii. Provisions made / released.

iv. Acquisitions / disposals.

v. Openings / closings Inc. discontinued operations,

impairment charges.

vi. FX effects / rates (translational and transactional);

vii. Changes in accounting policies / applications

viii. Estimated standalone costs.

ix. Basis (and consistency) of allocation of costs between

divisions;

x. Year-end prepayments / accruals process;

xi. Contribution from non-consolidated entities (i.e. JVs) or

other equity investments; and

xii. Revenues or expenses that are not at arm’s length basis.

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Valuation Approaches and Methods 3.8

The Valuer typically has a range of valuation approaches that can

be considered, individually or in combination with other approaches,

in valuing the Valuation Subject. However, there are three primary

approaches to estimate the value of the Valuation Subject:

3.8.1

3.8.1.1 Income Approach

i. The income approach is one of main valuation approaches,

based on the underlying principle of enterprise value being

equal to the present value of the future benefit streams

associated with ownership of the equity interest or asset. The

estimated future benefits that accrue to an owner should be

discounted using a capitalization or discount rate applicable for

the risks associated with the future benefits. Under the income

approach, the value of an asset is determined by reference to

the value of income, cash flow generated by the asset.

ii. Within the Income Approach, there are four primary methods

of converting expected benefit streams into value, all of which

will be covered in further details at a later stage. These include:

a. Discounted cash flow (DCF) method;

b. Capitalized cash flow method;

c. Dividend Discount Model (DDM); and

d. Excess Earnings Method.

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3.8.1.2

3.8.1.3

iii. The DCF method is one of the most widely used methods

for valuing a business under the Income Approach though

it is dependent on the preparation of prospective financial

information. DCF method is the most appropriate approach

when reliable forecasts are provided by management.

Market Approach

i. Under the market approach, the Valuer determines the

market value of the Valuation Subject, by relying on the pricing

multiples of publicly traded stocks of comparable companies

(guideline public company method) or price multiples of actual

acquisitions of comparable companies (similar transaction

method). The key factors in the selection of comparable

companies include industry, size, operations and life cycle.

ii. Within the Market Approach, there are two frequently used

valuation methods, both of which will be covered in further

details at a later stage. These include:

a. Comparable companies’ multiples method; and

b. Comparable transactions multiples method.

Asset Approach:

i. The Asset Approach is a valuation method based on the

underlying principle of substitution i.e. one would not pay more

for an asset than the price required to obtain (by purchase or

construction) a substitute asset of comparable utility.

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ii. Within the Asset Approach, there are three primary methods,

which includes:

a. Adjusted Net Asset Value (ANAV), when the assets values

are the main determinant of worth,

b. Liquidation Value, when the business is not viable,

c. Tangible Asset Backing, when there are no cash flows to

be capitalized.

Valuation methodology and approach selection 3.8.2

3.8.2.1 When selecting the appropriate valuation approach and

methodology, the Valuer should consider the following

factors:

i. Appropriate basis of value, determined by the scope and

purpose of the valuation engagement. For example, if the

valuation is required for:

a. IPO purposes, then using the Market and Income

Approach may be more appropriate. While the Income

Approach may result in a highly reliable valuation, Valuers

may consider the market approach since IPO are typically

“demand driven”.

b. Liquidation purposes, then using the Asset may be more

appropriate because it measures the liquidation values and

costs from selling off or liquidating the Company’s assets.

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ii. Appropriateness of each method in view of the nature of the

Valuation Subject such as its operational activities and its life

cycle stage. For example, if the Valuation Subject is:

a. Start-up with little or no revenues and negative earnings,

then using the Asset Approach may be more appropriate.

On the other hand, if the business is in its early stages of

its operations and reliable forecasts are available, then

using the Income Approach (specifically DCF) may be

more appropriate. This is primarily because the start-

up’s future performance which may be highly sensitive to

various economic, market and company specific factors

are indicative of the future value cash flows and prospects

of the business.

b. High growth company, with reliable forecast available,

then using the Income Approach (specifically DCF) may

be most appropriate. This is primarily because the financial

performance and accordingly market share of such

companies may change and make it difficult to compare

them with other more matured businesses.

c. Matured Company (i.e. companies which typically have

predictable financial results), then using the income or

market approach, may be more appropriate. Under the

Income approach, capitalized earnings are appropriate for

a mature business where it is not expected to experience

significant fluctuations in earnings. However, if the

underlying assets,

114

as opposed to the ongoing operations, are responsible for

a significant proportion of the value of the firm, then using

the Asset Approach may be more appropriate. In general,

DCF is appropriate for businesses that are planning to

experience growth or decline over the short term, before

reaching a steady/mature state and where reliable forecasts

are available.

d. A cyclical company (e.g. commodities companies or

asset management companies, which typically have a high

degree of uncertainty), then using the market approach

may be more appropriate. This is primarily because such

type of companies are economic and market factors are

immediately reflected in Comparables.

e. Distressed company, then using the Asset Approach may

be more appropriate because such companies typically

have negative earnings and cash flows, which makes it

difficult to develop forecasts. Even for companies planning

to restructure their operations, forecasts need to be made

until their cash flows become positive which may result in

negative values.

f. Asset approach is appropriate for businesses that are not

a going concern. However, if a business is a going concern,

the Asset approach is applicable for investment or real

estate holding companies where the companies’ value is

a conglomerate of assets which require the valuation to be

carried out, separately.

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iii. Availability of reliable information is required to apply the

appropriate valuation method. For example, if the Company

is operating in a niche industry where it is difficult to find large

number of comparable firms being traded on financial markets

(and which are priced correctly), then placing higher weight

on the Income Approach may more appropriate. Alternatively,

if the Valuation Subject’s Management do not have an up to-

date business plan prepared and they may be facing practical

difficulties in forecasting future cash flows, then using the

Market and/or Asset Approach may be more appropriate. An

alternative method can be using capitalization of historical

cash flows if the business is expected to have steady cash

flows.

iv. The Valuer should weigh the valuation results developed

under different valuation approaches to arrive at an overall

valuation conclusion. The Valuer should always attempt to

reconcile the valuation under the primary approach with

a secondary methodology to ensure that the assumptions

adopted in the primary methodology are appropriate.

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Income Approach3.8.3

3.8.3.1

3.8.3.2

Overview

i. The Income Approach determines the value of a business

based on its ability to generate desired economic benefit for the

owners. Hence, its key objective is to determine the business

value as a function of the economic benefit, which is typical the

free cash flow.

ii. Within the Income Approach, there are three primary

methods of converting expected benefit streams into value:

a. Discounted cash flow (DCF) method;

b. Capitalized cash flow method; and

c. Dividend Discount Model (DDM)

iii. The DCF method is one of the most widely used methods,

under the Income Approach.

DCF Method

i. This method uses present value concept where the value of

any asset is the present value of expected future cash flows

that asset generates. In this regard, the value of the Valuation

Subject using this approach is based on the following formula:

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Formula 1: Enterprise and Equity Value Calculation based on the DCF Method

ii. When carrying out the valuation using the DCF method, the

Valuer shall:

a. Review and analyze the Prospective Financial Information

b. Choose an appropriate type of cash flow based on the

nature of the Valuation Subject (i.e. Free Cash Flow to Firm

or Free Cash Flow to Equity, which is covered in further

details, in the following section).

c. Calculate the selected type of free cash flow (i.e. FCFE

or FCFF) of the Valuation Subject based on Management

Business Plan.

d. Determine the appropriate discount rate to apply on

the projected free cash flows. For example, if the Valuer

considers FCFE cash flows, cost of equity is to be

determined and for FCFF cash flows, cost of capital is to

be determined.

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i. Prospective financial information analysis (“PFI”)

includes an entity's financial position, results of

operations, cash flows, or elements thereof for one or

more future dates or periods. It can be in the form of

a forecast, a projection or a combination of both. For

example, a one-year forecast plus a five-year projection.

ii. As the PFI is based on a mixture of best-estimate

and hypothetical assumptions of future events and

possible or expected management actions, they are

highly subjective in nature. In this respect, the Valuer

should have a clear understanding of the performance

drivers and conduct reasonableness checks on the

financial projections and underlying assumptions for

consistency with identified and expected trends from two

perspectives: the vmarket outlook in which the company

operates and the Valuation Subject’s own operating and

financial characteristics/historical performance.

iii. As part of the review process, the Valuer should carry

out the following:

a. Review the Valuation Subject’s financial model and express an opinion around its logical integrity and arithmetical accuracy. Valuers are not responsible for the PFI. However, they should assess the reasonableness of the assumptions used and accordingly assess the appropriate discount rate that would capture the risks associated with achieving these forecasts;

3.8.3.2.1 Prospective financial information analysis

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b. Validate first year’s forecast based on the year to date performance and the pipelined projects or signed order book with the company. c. Assess the projected revenue growth rates taking into consideration the size of market, Company’s size, historical growth rate, operating model, growth plans, market outlook and magnitude and sustainability of competitive advantage; d. Assess the gross and operating margins based on the Company’s historical performance and margins achieved by the comparable companies. Valuer may get access to competitor›s information through annual reports, investor presentations and analyst reports of comparable companies; e. Assess whether the capital expenditure estimates appear to be sufficient to sustain the future growth rates the company has forecasted;f. Validate if there is enough workforce to achieve the forecasted growth rates and what will be the increase in direct costs and fixed expenses to achieve the forecasted margins;g. Understand how the Company manages its working capital and accordingly assess the reasonability of working capital assumptions; otherwise what are the basis for the change in policy, if any; andh. Validate if the company can access adequate funding (equity or debt) for the capital expenditure goals in the future.

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iv. In the absence of a detailed up to date business

plan, the Valuer may support the Valuation Subject’s

Management with the below steps. Alternatively, other

valuation approaches and methodologies (which will be

covered in the following section) may be considered.

a. Developing an excel-sheet financial model for the Company based on the identified cost and revenue drivers for the agreed-upon projection period;b. Co-developing the financial projections using assumptions provided by Management. Since PFI prepared by the Valuer may inherently incorporate the Valuer’s bias and accordingly may jeopardize the independence of the valuation opinion to be provided, the Valuer may only support the Company’s Management in developing their forecasts through providing his/her/its integrated insights based on the market and financial statement analysis undertaken. Accordingly, validating PFI may be permissible but full preparation of PFI should be out of the scope;c. Analyzing financial projections and the underlying assumptions for consistency with the identified business trend(s), as appropriate; andd. Reviewing the results of the projections and recommending modification, based on Management’s inputs, as appropriate.

i. The Valuer may select from one of the two conventional

valuation basis are “Free Cash Flows to Equity (FCFE)”

and “Free Cash Flows to Firm (FCFF)”, where:

a. Free cash flow to equity (FCFE) is the cash flow available to the firm’s common stockholders once operating expenses (including taxes), expenditures needed to sustain the firm’s productive capacity, and payments to (and receipts from) debtholders are accounted for.

3.8.3.2.2 Cash flows Selection

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b. Free cash flow to the firm (FCFF) is the cash flow available to all the firm’s suppliers of capital once the firm pays all operating expenses (including taxes) and expenditures needed to sustain the firm’s productive capacity. The expenditures include what is needed to purchase fixed assets and to fund working capital, such as accounts receivable and inventory. The firm’s suppliers of capital include common stockholders, bondholders, and preferred stockholders (if the firm has preferred stock outstanding).

ii. FCFE are considered for companies with stable leverage and FCFF are considered for companies whose capital structure is expected to change overtime, primarily through increasing debt.

i. Both FCFF and FCFE can be computed from Net Income, cash flow from operations, EBIT or EBITDA, as detailed below:

3.8.3.2.3 Free Cash Flows Calculation

Formula 1: Free Cash Flow Calculation

Determining FCFF from Net Income:

FCFF=Net Income+Non cash expenses+interest expense*(-1tax rate)-Change in working capital-Investment in fixed assets Determining FCFF from cash flow from operations:FCFF=Cash flow from operations+interest expense*(-1tax rate)-Investment in fixed assets

Determining FCFF from EBIT:

FCFF=EBIT*(-1Tax rate)+Depreciation expense-Change in working capital-Investment in fixed assets

Determining FCFF from EBITDA:

FCFF=EBITDA*(-1tax rate)+Depreciation expense*tax rate-Change in working capital-Investment in fixed assets

Determining FCFE from FCFF:

FCFE=FCFF-Interest expense*(-1tax rate)+net borrowing

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ii. Some of the key non-cash adjustments that the Valuer should make either to Net Income, Cash Flow from Operations, EBIT or EBITDA are:

Other adjustments include:

a. Working capital, which includes inventory, current assets, advances, inventory, trade receivables and payables, etc. typically represent a cash movement. Accordingly, the selected benefit stream shall be adjusted by the change in working capital, while making sure that cash and other non-operating items like inter-company loans given to group companies, provisions for tax/zakat and dividend while calculating investment are adjusted for;

Non-cash / non-operating expense

Adjustment to net income

Depreciation & amortization expense

added back

Impairment of intangibles added back

Fair value gains subtracted from

Provisions for restructuring charges and other non-cash losses

added back

Income resulting from reversals subtracted from

Gain from sale/ disposal of any asset

subtracted from

Loss for sale / disposal of assets added back

Amortization of bond discount added back

Accretion of bond premium subtracted from

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b. Investment in fixed assets represents the cash outflow made to purchase fixed assets necessary to support the company’s current and future operations. Accordingly, the earnings shall be adjusted by the investment in fixed Furthermore, the Valuer should make sure that capital work-in progress and capital advances in property plant & equipment is included, while computing the capital expenditure for the year.

Example 4: FCFF and FCFE calculationASN & Co. was incorporated in 1993 and currently operates as a

construction and engineering contracting company in Middle East. Calculate FCFF and FCFE for the company for the year ended 31

December 2016 based on the data below:

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i.The application of DCF method requires the determination of an appropriate discount rate at which future cash flows are discounted to their present value as at the Valuation Date.ii. The discount rate reflects the perceived risk associated with projected future cash flows, cost of capital and inflation. It is derived based on the expected return on capital and the price of the best alternative investment. iii. As the return on this alternative investment must be comparable in terms of dimensions, timing and certainty, with the net cash flows expected to be derived from the subject asset, Cost of Equity (COE) is the appropriate risk adjusted rate for discounting FCFE and weighted average cost of capital (WACC) is the appropriate risk adjusted rate for discounting FCFF.

i.To calculate the Valuation Subject’s WACC, the Cost of Equity, Cost of Debt and the capital structure have to be determined, as detailed below. However, in calculating the discount rate, the Valuer has to consider the Valuation Subject’s future capital structure, which is typically the average capital structure of comparable companies.

3.8.3.2.2.4

3.8.3.2.4.1

Estimating Discount rate

WACC

Formula 2: WACC Formula

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Formula 4: Cost of Debt Formula

i. The expected return that debt holders would accept when investing in a default risk security i.e. risk of receiving their promised payments in form of interest payment and principal repayments is termed as Cost of Debt (COD). ii. COD is a function of risk free rate and a default spread. However, as the interest payments is an allowable deductible expense as per the Saudi tax and zakat

i.The expected return for equity investment in the Valuation Subject is termed as Cost of Equity (COE). ii.There are many methods to determine COE, a non-exhaustive list of common methods includes Capital Asset Pricing Models (CAPM), arbitrage pricing model, build-up model and multi-factor models. However, CAPM is the most common method used to calculate the COE.iii.CAPM estimates the required rate of return by investors taking into consideration the Valuation Subject’s risk profile; the expected return is a function of four variables, which are risk free rate, the beta of the valuation subject, the equity risk premium and additional company-specific risk premium, as expressed by the following equation:

regulations, will factor such benefit. Hence, the Valuer should consider after-effective tax and zakat cost of debt in determining the COD.

3.8.3.2.4.2

3.8.3.2.4.3

Cost of debt

Cost of equity

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Formula 4: CAPM

Formula 5: Risk free rate calculation

a. Risk-free rate

i. The risk-free rate of return is typically obtainable from a government security of equivalent maturity to the projection period and consistent with the currency considered in the projections. The Valuer may use the yields on the -30year US treasury bonds, and if the forecast currency is in Saudi Riyal, adjust for the inflation differential between US and Saudi Arabia. Alternatively, the Valuer could directly use the yields on the Saudi government long term bonds. However, if the Valuer is carrying out the valuation in other currency, which is not pegged to the dollar, the nominal risk-free rate can be estimated as follows:

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b. Country risk premium

ii.The Valuer should add a country risk premium if real risk free rate is used. This is because political and economic risks are not factored into the local bonds yield. iii.The country risk premium is estimated based on the country’s economic and political environment. For example, a higher discount rate would be applied to countries with high inflation and unemployment rates and/or unstable currency and political environment, as stability tends to positively contribute towards the return patterns.iv. A reliable source for extracting and quantifying specific country risk premium is Duff & Phelps international cost of capital.

c. Beta

i. Beta is a measure of the level of non-diversifiable risk associated with guideline company returns. It is based on how a share price moves for a particular industry relative to the stock market and is thus a measure of its relative volatility; a beta higher than one implies that the systematic risk of the company’s stock is higher than the market risk; ii.The Valuer can estimate beta using statistical techniques and historical data, preferably based on the closing prices for comparable companies, over a three to five-year period. The standard approach for estimating beta is to run a regression of returns on a company’s equity against returns on an equity market index and the slop captures how the company’s equity changes with changes in market. Typically, betas with Coefficient of Determination (R-Squared) of %10 or more should be used since they signify a greater correlation to the market;iii.Betas reported in public sources are leveraged, which means that the additional risk to a stockholder due to the debt financing of the company is incorporated in the corresponding beta coefficient. In this respect, when calculating the cost of equity for the Valuation Subject, the industry beta needs to be unlevered and re-levered to take into consideration the differences in capital structure, using the following formulas.

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Formula 6: Un-levering and Re-levering Beta

d. Market Risk Premium

i. The market risk premium is defined as the difference between the expected return on a market portfolio and the risk-free rate; it is the premium that investors demand for investing in risky investments relative to risk-free ones. This is primarily attributed to the results of the empirical studies conducted, which indicated that investments in shares have historically yielded higher returns than investments in low-risk bonds. ii.A reliable source for extracting and quantifying for the market risk premium is Duff & Phelps international cost of capital publications.iii.The following factors are to be taken into consideration when estimating the market/industry risk premium.

• Barriers to market entry: Where barriers of entry are high, existing market players are better protected and accordingly the required rates of return generally are lower; the converse is also true.

• Raw material sources, prices and price trends. Companies are exposed to higher risk when there is dependence on relatively few suppliers and where raw materials prices have been volatile.

• Technology: Companies are exposed to higher risk if the impact of continually escalating technological change in the business, both from an internal and/or external perspectives is high.

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e. Equity Size Premium

i. Equity size premium is added to CAPM calculations to capture additional return expectations on small companies. The investors demand a higher rate of return on small companies than they do on large companies due to the increased risk associated with investments in small companies.

f. Company Specific Risk Premium

i. A company specific risk premium is added in the CAPM calculation to capture the inherent operational and financial risk the business is exposed to, such as:

• Product/service offering risk: a lower discount rate would be applied where a product or service is protected by patent, exclusive agencies or copyright, or has brand name recognition than if no such protection existed.

• Fixed assets condition; a lower discount rate would be applied if plant and equipment are well maintained, appear to suffer relatively little physical and technological obsolescence over time than if the opposite was true.

• Labour-intensive business; Discount rates applied in a labour intensive business would generally be higher than those applied in a capital intensive business.

• Type of contractual arrangement the Valuation Subject has (e.g. franchise agreements leases etc.). The Valuer should apply a lower discount rate if the Valuation Subject has long-term contracts or exclusive franchise agreement in place, which by themselves may have an open market value, than if they do not exist or in the case of franchise agreement are non-exclusive or the risk of non-renewal may be high.

• Customer concentration risk; a higher discount would be applied if the company is highly dependent on few customers.

• Financial risk base on the Company’s capital structure. The higher the debt to equity rate as compared to the industry average, the greater the financial risk and the higher the discount rate.

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Example 5: WACC CalculationThe following table illustrates the WACC calculation for ASJ & sons

i. Future free cash flows will be discounted using the discount rate determined in the previous phase, on the following basis:

Cash Flow / (1 + Discount Rate) ^ (Year-Valuation Date)

ii. The above method assumes that the free cash flows for a given year come at the end of that year. However, this may be inaccurate if the cash is generated throughout the year.iii. To account for this, a mid-year discount should be used to assume that the cash flows occur evenly during each of the measurement period. Hence, the following formula may be used:

Cash Flow / (+1Discount Rate) ^ ((Year-Valuation Date)0.5-)

iv. Using mid-year discounting factor is considered to be best practice for discounting free cash flows as the cash flows to the business typically occur through-out the year. However, where the cash flows of the Valuation Subject are not earned evenly throughout the year, a year-end discounting period can be applied based on the economic reality of the Valuation Subject. The Valuer needs to assess whether a mid-year or year-end discounting is appropriate.

3.8.3.2.2.5 Discounting future cash flows

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i. The final component of DCF is the terminal value, which is the estimated value of the Valuation Subject beyond the explicit forecast period, whether the cash flow generated is contractual in nature (non-renewable franchise agreement, single project joint venture etc.) or based on a depleting-resource nature (such as a mine, oil well etc.). Typically, there may be residual net assets, which could be realized, converted into cash and distributed to the business owners. ii. Therefore, the terminal value would be discounted back to the present value using the last year’s discount rate to arrive at the present value of terminal value; andiii. Valuer can compute terminal value in one of the following three methods.

a. Gordon growth method

i. This method assumes the company will generate free cash flows at a normalized rate until perpetuity, which is known as the Terminal Growth Rate (TGR). This rate is usually assumed to be in line with the inflation with the GDP growth rate as a ceiling rate. ii. The TGR could be zero if the cash flows are assumed not to reach to inflation level into perpetuity, which may be the case when companies receive fixed income, with no inflation adjustments in contracts i.e. property management companies.

3.8.3.2.2.6 Terminal value

Formula 7:Terminal Value calculation based on Gordon Growth Model

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Example 6: Terminal Value calculation based on Gordon Growth Model

The following table illustrates calculation of the Terminal value (TV) using Gordon growth method

b. Exit multiple approach

i. The exit value, also referred to as terminal multiple method assumes that the business will be valued at the end of the projection period, based on public market valuations.ii. The terminal value is computed by applying an appropriate multiple (of earnings, revenue or book value) to the relevant statistic projected for the terminal year. Since these multiples are obtained by analyzing the current trading levels of comparable firms in the market, this is a relative valuation rather than a discounted cash flow valuation. iii.Using current multiples impacts the current expectation of growth to cash flows occurring in the future and may overstate terminal value.iv.The calculation and application of valuation multiples is discussed in detail in the Market approach section.

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Formula 8:Terminal value calculation based P/E multiple

c. Salvage value

i. Only applies when a business is expected to a finite life (i.e. operation of a mine) and it would be a DCF forecast based on the actual life of the Valuation Subject rather than a 5 year cash flow plus residual value of the counts i.e. if mine has 25 year life from Valuation Date, would see a 25 year forecast and last year showing the liquidation value or salvage value of the assets.ii. Salvage value is the estimated resale value of an asset at the end of its useful life.iii. The terminal value of some assets with limited useful life like mining projects, road projects are typically calculated as salvage value of the asset less cost to dispose of the asset.

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iv.While terminal value is computed either by constant growth method or exit value approach or liquidation value, the resulting terminal value should be crosschecked using other methods. For example, if Valuer used constant growth model to arrive at the terminal value, the implied multiple should be computed and compared with the industry multiples. Likewise, if the Valuer considered exit multiple to arrive at the terminal value, the implied terminal growth rate should be computed to insure that it is not significantly far-off from economy’s growth rate.

Example 7: Terminal value calculation based on P/E multiple

Abdullah & Co. will generate SAR 60 Mn of revenues 10 years from now and the exit price to sales multiple for the industry at the terminal year is 2.0x. The terminal value at the end of 10th year would be 60x2

= SAR 120 Mn.d

Formula 9:Implied Terminal Value

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Example 8: Capitalized Cash Flow Method

Calculate enterprise value and equity value of BCD & Co using capitalized cash flow method based on the data below:

Formula 10: Enterprise and Equity Valuation based on Capitalized Cash Flow Method

3.8.3.3 Capitalized Cash Flow Method

i. This method is also known as capitalization of earnings

method and is typically used when projections are uncertain

and stable growth is a reasonable assumption.

ii. Hence, under this method, free cash flow for a single year is

divided by a capitalization rate to arrive at the enterprise value,

where the capitalization rate is the required rate of return minus

a sustainable growth rate, as illustrated through the formula

below. Further, a supporting example is included in the page

overleaf.

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3.8.3.4 Dividend Discount Method

i. The dividend discount method is a technique of valuing

company, on the basis that a price of stock is equivalent to the

sum of all of its future dividends, discounted to present value.

This technique is primarily used to value minority interest in a

company.

ii. The model uses dividend payments, cost of equity and

growth rate of company to calculate the value of stock. It

is predominantly used for valuation of financial services

companies, because of difficulties in estimating their cash

flows.

vii. Assuming stable growth for the company (which is usually

true for mature companies), this can be rewritten asEquity

value= Dividend ; g is the sustainable growth rate of dividends,

and dividend is dividend at time period = 1 (i.e. next year),

assuming valuation is being done at time = 0.

The main limitation of DDM arises as it assumes a stable and

fixed growth rate for the company, which most of the times is not

correct and improbable. Additionally, it assumes that the firm

pays out whatever dividend it can, rather than it being based

on management’s decision. It is very difficult to forecast how

much and when dividends will be paid out, by a non-dividend

paying firm. DCF does not have this limitation, and hence is

applicable for more situations.

(COE-g)

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3.8.3.5 Excess Earnings Method

i. Excess earnings are the company earnings less the earnings

required return on working capital and fixed assets.

ii. This method can be used for small firms where their intangible

assets are significant.

iii. Under excess earning method or residual income method,

enterprise value will be as follows:

Formula 11: Equity Value based on Discounted Dividend Method

Formula 12: Enterprise Value based on excess earnings method

Enterprise Value = Working Capital + Fixed assets + value of intangible assets

Present value of Value of intangible assets = Present value of excess earnings

Example 8: Discounted Dividend Method

Calculate enterprise value of Abdullah Abdul Sons & Co using discounted dividend method based on the data below:

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iv. Steps in applying excess earning method are:

i. Estimate fair value of working capital and fixed assets;

ii. Determine the normalized earnings of the company;

iii. Develop discount rates for working capital and fixed assets.

Working capital is viewed as the lowest risk and most liquid

asset with lowest rate of return. Fixed assets require higher rate

of return compared to working capital;

iv. Calculated required return for working capital and fixed

assets and deduct the same from normalized earnings to

determine excess earning of the company;

v. The excess earnings are capitalized using a cap rate to

estimate the value of intangible assets; and

vi. Calculate the value of firm: the value of firm is the sum of

working capital, fixed assets, and intangible assets.

Example 9: Enterprise calculation based on excess earnings method

Calculate enterprise value of ABC Sons & Co using excess earnings method based on the data below:

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Market approach

i. The Market approach is based on what other purchasers in

the market have paid for companies that can be considered

reasonably similar to Valuation Subject being valued.

ii. Two frequently used valuation methods under the market

approach are Comparable companies’ multiples method and

Comparable transactions multiples method.

iii. Valuation under both methods are typically carried out using

Price Multiples and Enterprise multiples from trade data for public

companies and public and private transactions, where:

a.Price multiples are ratio of company’s market price per share

to some fundamental value of the company per share. The

below are the non-exhaustive list of price multiples.

i.P/E multiple: There are two versions of P/E ratio: trailing

and leading P/E. P/E multiple is reasonable multiple if the

Valuation Subject has similar capital structure of comparable

companies.

ii. P/B multiple : price to book multiple is defined as

iii. P/S multiple: price to sales multiple is defined as

3.8.4

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b. Enterprise multiples are ratio of enterprise value of

a company to some measure of fundamental value of the

company. The below are the non-exhaustive list of enterprise

multiples.

iv.EV/EBITDA multiple: EV to EBITDA multiple is the widely used

enterprise value multiple. It is the valuation indicator for the overall

company rather than solely equity.

v. EV/sales multiple: EV/sales is a major alternative to P/S multiple

and is only appropriate if the Valuation Subject and comparable

companies have similar profitability.

vi. In limited situations, alternate multiples based on non-financial

data can provide useful insight, especially for new companies

with unstable revenues or negative profitability. This non-financial

multiple must be reasonable predictor of future value creation

and correlated with the growth and Return on Invested Capital

metrics. For example, to value internet start-ups, the Valuer may

use Enterprise value to website hits, enterprise value to number

of subscribers, enterprise value to unique customers. The Valuer

should consider the Asset Approach as a sanity check to ensure

that the valuation conclusion is reasonable, given the state of the

business.

vii. Notwithstanding, the prerequisite for applying market approach

is existence of regular and free trades in company’s share and

availability of reliable data on such comparable companies and

transactions. This method is considered the best method for

valuation of shares if the above prerequisites are satisfied.

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viii. Another prerequisite is that comparable companies should be

similar in terms of size (i.e., revenues, net income, etc.), product/

services offering, industry, growth prospects etc.

2.8.4.1 Comparable companies’ multiples method

i. Comparable companies’ multiples method, also known as

guideline multiples method considers information of publicly

traded comparable assets that are similar to the Valuation

Subject to arrive at the value. This method can be used to

value both publicly listed companies and privately owned

companies.

ii. The Valuer should follow the steps outlined below while

using comparable companies’ multiples method to value a

company:

a. Identify the multiple that is relevant for the industry,

the financial performance of Valuation Subject and

purpose of the valuation. While EV/EBITDA is one of the

most commonly used valuation multiples, since EBITDA is

considered as a proxy for cash flow available to the firm;

however, other multiples are used when the Valuation

Subject has negative EBITDA and/or when the company

holds a large number of liquid assets such as finance,

banking and insurance companies. Also, certain industries

have preferred multiple; for example, P/AUM multiple is

frequently used for asset management businesses and

P/B multiple for banking, financial institutions and real

estate industries.

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b. Identify the guideline-traded companies that are similar

to Valuation Subject (peer companies). This includes

examining the companies in similar industry of Valuation

Subject. Potential resources include annual reports, market

research reports, and/or standard industry classification

code;

c. Perform a comparative analysis of qualitative and

quantitative similarities and differences between the

identified peer companies and Valuation Subject. The

analysis shall highlight the following difference:

i. Growth and profitability metrics (E.g., Return on

Invested Capital, revenue CAGR, EBITDA CAGR).

ii. Valuation Metrics taking into consideration the growth

trajectory, capital structure, etc. For example, enterprise

value multiples are less susceptible to distortions caused

by the company’s debt-to-equity ratio; however, P/E ratio

will be impacted by change in capital structure.

d. Calculate the mean, median or weighted average of

multiples of all the relevant comparable companies in

the peer group, noting that the median is typically more

representative of the dataset since it is not affected by

outliers and subsequently, select the appropriate multiple

to be used.

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e. Apply appropriate discounts/ premiums, if any, to the

multiple to reflect differences between the Valuation Subject

and the peer companies. For example, a company with

good prospects for growth and profitability relative to the

comparable companies should trade at higher multiples

than its peers;

f. Apply the adjusted multiple to the Valuation Subject’s

financial metrics; and

g. Adjust the Enterprise Value by non-operating items such

as excess cash and net debt to arrive at the Equity Value. The

Valuer can add back the full amount of cash and equivalents

on the balance sheet if excess cash is difficult to estimate.

Example 10: Valuation using the comparable companies’ method

Calculate equity value of Abdullah Abdul Sons & Co using comparable companies under the market approach method based on the data below:

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2.8.4.2 Comparable transactions multiples method

i. Comparable transaction multiples method, also known

as guideline transaction method considers deal multiples of

transactions involving assets that are similar to the Valuation

Subject to arrive at the value.

ii. The key steps in the comparable transactions multiples

method:

a. Identify the relevant comparable transactions and

calculate the key valuation multiple/deal multiple for those

transactions;

b. Identify the valuation multiple that are used by

participants in the industry of Valuation Subject;

c. Identify whether the transaction is for a minority or

majority stake;

d. Perform a comparative analysis of qualitative and

quantitative similarities and differences between the

comparable assets and the Valuation Subject.

e. Select similar transaction multiple from data set.

f. Apply appropriate discounts/ premiums, if any, to

the multiple to reflect differences between the current

transaction and the comparable transactions. For example,

if comparable transaction considered in a strategic

transaction and firm value was based on synergies and

Subject Company’s ongoing/ potential transaction is non-

strategic in nature,

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the Valuer must adjust the comparable multiple to take into

consideration the large portion of contingent consideration

in its purchase price. In reality, it is difficult to access control

premiums/ discounts for lack of control. Control premium is

quantified as the excess of the price for a controlling stake

in the target company being acquired over its publicly

traded share price. Audit and Valuation firms publish control

premium studies that measures the control premium over 10

years/ 15 years period;

a. Apply the adjusted valuation multiple to the financial

metric of Valuation Subject (if applicable);

b. Adjust the Enterprise value by non-operating and

net debt items to arrive at the Equity Value. When using

multiples such as P/E, P/S, P/AUM net debt does not

need to be adjusted for; and

c. Apply appropriate discounts/ premiums (e.g. discount

for lack of marketability and/or control), if any, to the

valuation multiple to reflect differences between the

percentage of interest of Valuation Subject being valued

and the comparable transactions. The Valuer decides

whether a marketability discount is appropriate depending

on the purpose of valuation (e.g., even if the Valuation

Subject is private company, it may not be appropriate

to consider marketability discount if the purpose of the

valuation is for immediate liquidity event).

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Example 11: Valuation based comparable transaction method

Calculate equity value of Fazan Finance Co. using comparable transaction under the market approach method based on the data below:

• Fazan Finance Co. is a financing company in Saudi Arabia with operations across the middle East;• The size of Abdullah & Co is very small in terms of revenues and no of clinics compared to comparable companies in the industry; • EBITDA of Abdullah & Co for the year ended 31 December 2016 is SAR 303.5 Mn; and• Market value of Debt for the year ended 31 December 2016 is SAR 903.2 Mn

Solution: Methodology: The following transactions have taken place in the last 2 years:

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Asset Approach

i. The Asset Approach stems from the underlying principle of

enterprise value of a company being equivalent to the value of its

assets less the value of its liabilities.

ii. Within the Asset Approach, there are three primary methods,

which includes:

a. Adjusted Net Asset Value (Adjusted NAV)

b. Liquidation Value

c. Tangible Asset Backing

iii. The frequently used methods in Asset Approach are the

Adjusted Net Asset Value (Adjusted NAV) and Liquidation Value.

Adjusted NAV is typically used when the Company is a going

concern and Liquidation Value method is typically used when it is

not a going concern.

iv. While valuation using the asset approach, typically results in

a lower value as it ignores business potential, does not consider

intangibles and is impacted by accounting practices, it may be

more appropriate to consider it when valuing:

a. A holding company such as real estate investment trusts

(REITs) and closed end investment companies (CEICs). Since

the underlying assets typically consist of real estate or securities

that were valued using market and/or Income Approaches,

using asset-based approach may be appropriate.

3.8.5

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b. Asset company, not earning returns in excess of its capital,

where the underlying assets, as opposed to the ongoing

operations, are responsible for a significant proportion of the

value of the firm; and/or

c. Losses are continually generated by the business. For

example, company with nominal profits or losses and without

prospects of positive cash flow in the future is vest valued using

asset-based approach. In this case, going concern valuation

might be less than its liquidation value.

3.8.5.1 Adjusted NAV

i. Under this method, the Company’s assets and liabilities are

adjusted to their current market value.

ii. The Valuer should carry out the following steps when valuing

the Valuation Subject using the Adjusted NAV method:

a. Analyze the balance sheet of Valuation Subject as at the

Valuation Date;

b. Restate the assets and liabilities to their market value;

c. Identify the unrecorded assets and liabilities and their

impact on the valuation; these can be unrecorded intangible

assets, off-balance sheet commitments or contingent assets

that are not on the balance sheet.; and

d. Add debt and deduct cash & cash equivalents and other

non-cash surplus assets to arrive at enterprise value from/

NAV method as detailed in the following example.

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3.8.5.2 Liquidation Value

i. Liquidation value is valued as the sum of estimated sale

proceeds of the assets owned by the company taking into

consideration the situational urgency of the seller.

ii. There are two different liquidation approaches, which are

forced liquidation and orderly liquidation, as explained below:

a. Force liquidation assumes that the assets of a business

are sold as quickly as possible; often at distressed prices.

b. Orderly liquidation assumes that the assets of a business

are sold over a relatively longer timeframe, in an effort to

maximize the proceeds. However, these proceeds at times

are offset by the costs incurred during the period of orderly

liquidation.

Example 12: Valuation based on the Adjusted NAV method

Calculate net asset value of AlJM & Co using the Adjusted NAV method based on the data below, assuming that all assets and liabilities have been recognized at their

market value:

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It is typically used when the net proceeds exceeds the

proceeds of a forced liquidation. Under this approach,

each major asset or group of assets should be reviewed to

determine which of the two approaches is more appropriate.

iii. The liquidation value approach is used in the following

situations:

a. If the Valuation Subject’s earnings are so insignificant, on

a sustainable basis, to the extent that the application of an

appropriate capitalization rate to those earnings results in a

value lower than the liquidation value.

b. Where a business is properly valued as a going concern but

its value is related to the going concern value of its underlying

assets. Real estate and investment holding companies are

the most common examples.

c. Where the Company has a going concern issues and

therefore should be liquidated.

iv. Liquidation values is calculated through undertaking the

following steps:

a. Determining shareholder equity as at Valuation Date.

b. Restating assets and liabilities to the market value. As

liquidation value is based on net realizable values, assets and

liabilities should be analyzed and any required restatement

should be undertaken. Please refer to appendix for a non-

exhaustive list of adjustments. Furthermore, the Valuer may

seek the opinion of Subject Matter such as property and

equipment appraisal, if required.

151

c. Calculating the costs of disposal of assets;

d. Calculating the taxes payable upon disposal of the

assets, if any; Calculate the taxes payable upon distribution

of the “net cash pool” to shareholders, if any. (Tax/Zakat

advisor opinion shall be sought at the time of disposal.)

Tangible asset backing

i. The Valuer should calculate the liquidation value and tangible

asset value at the same time.

ii. Tangible asset backing represents the total fair market

value of all tangible and intangible assets (goodwill excluded)

determined for a going concern basis, less all liabilities. No

deduction is made for liquidation costs and deferred income

taxes are generally ignored depending on the circumstances.

iii. Hence, the Valuer should determine the Tangible asset

backing before goodwill can be quantified since good will is

equivalent to the going concern value of the company less

tangible asset backing.

Example 13: Liquidation value calculation

Calculate the liquidation value of Hassan Co. as at 31 December 2016 based on the following information.:

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Net Debt3.9

Net debt is the company›s total debt minus its cash and cash

equivalent.

When carrying out the valuation analysis based on the income

approach or market approach using the enterprise value multiples,

the Valuer would need to calculate the real debt level of the Company

to arrive at the equity value as at the Valuation Date.

When calculating net debt, the Valuer should include debt and “debt

like” items in calculating the total debt levels of the Company.

While debt owed to banks and other financial institutions can easily

be determined, “debt like items” are usually open to interpretation

based on the valuation perspective i.e. seller or a buyer. From the

buyers perspective higher debt levels will minimize the equity value,

while the seller will like the debt levels to be as low as possible to

drive the equity value up.

“Debt like” items may include capital expenditure payables, contingent

liabilities, deferred revenue and potential litigation payments amongst

others. A list of items to consider debt and “debt like” items are as

follows:

3.9.1

3.9.2

3.9.3

3.9.4

3.9.5

153

i. Indebtedness for borrowed money;

ii. Obligations backed by a note, bond, debenture and similar

instruments;

iii. Capital finance lease obligations;

iv. All-non-interest bearing debt owed to financial institutions;

v. All debt owing to shareholders or their associates, including

accrued interest thereon (excluding trade related);

vi. All recourse liabilities and other liabilities arising from any

transaction related the assignment of receivables for financing

purposes;

vii. Accrued interest; and

viii. Shareholders/associates current accounts

Cash items may include the following:

i. Cash and non-cash equivalent; and

ii. Non-revolving deposits

It is also important to note that a “negative net debt” implies that the

company has more cash than it owes, which is often regarded as a

sign of financial strength and stability.

3.9.6

3.9.7

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Non-operating Assets3.10

The Valuer must be aware of the possibility of the presence of non-

operating assets and that their existence may significantly affect the

value of the Valuation Subject. In this respect, during the analysis, the

Valuer carefully review the financial statements over several years to:

i. Identify and analyze any non-operating assets

ii. Estimate the revenues generated from non-operating assets:

While they are typically reported as “other income” (e.g. interest

on terms deposits or portfolio dividends) and can be easily

confirmed, the Valuer needs to confirm their nature and amounts

with Management.

iii. Estimate the Associated Expenditures. A more detailed

examination of the Company’s records (e.g. property taxes and

interest costs on redundant land if not capitalized; depreciation

charged against unused machinery; or utility expenses of a

rental warehouse) may be required to assess the associated

expenditures.

iv. Exclude these amounts in the valuation of a business on a

going-concern basis (i.e. typically when the market and/or income

approaches). The revenues and expenditures relating to non-

operating assets must be eliminated from maintainable earnings

in a going concern valuation.

v. On the contrary, when valuing the Valuation Subject using the

asset approach, separate consideration of non-operating assets

is not critical other than in respect of the degree to which zakat

and income taxes underlying these assets may be recognized.

3.10.1

155

vi. A non-exhaustive list of non-operating assets is listed below:

a. Portfolio investments;

b. Other investments and loans;

c. Excess borrowing ability;

d. Excess land, buildings or equipment (e.g. of real estate not

required for future business expansion; a property capable

of subdivision; unused space in a warehouse (if capable of

leasing to outsiders); or investment in unused machinery); and

e. Unused intangibles including unused patents, licenses

trademarks, copyrights, formulae, franchises and other similar

contractual rights. It is challenging to assess the value of

intangibles, which are not in use for the following reasons:

1. It is difficult to distinguish the cash flows uniquely related to

the intangible asset from the cash flows of the Company, or

2. It is difficult to find market based transactions of similar

intangible assets recently exchanged in an arm’s length

transactions.

f. Underutilized land or building where the asset has higher

return than its current state of use. If the land or building is

more valuable if sold or operated on cheaper location, then

the value of underutilized land and building will be the above

value of land and building after deducting cost of relocation.

156

vii. Excess Working Capital

a. Excess working capital can be estimated through comparing

the working capital of the Valuation Subject by:

i. Industry averages, as reported by various industry

association publications and/or annual reports of public

companies;

ii. The historical Current and Acid Test ratios as at the Valuation

Date. However, the Valuation Subject’s management or an

independent banker can advise the Valuer the degree of

excess working capital required and confirm that funds are

not required to finance an increase volume of business and/

or secure financing that cannot otherwise be obtained.

viii. Excess Fixed Assets

a. The Valuer may identify excess/surplus fixed assets through

discussions with management assess its implication based on

a detailed analysis of the fixed assets register, legal documents

including deeds. Based on the analysis the Valuer should be

able to understand the following:

i. How the purchase of the fixed assets is financed;

ii. Whether they can be sold and/or whether they are secured

by a debt instrument and cannot be sold unless the debt is

repaid have mortgages or debt instruments secured against

them.

157

iii. Valuation of surplus assets is dependent on the purpose

of the valuation and the usage of that surplus asset. Surplus

assets can be taken at fair market value or liquidation value.

For example, if the management of Client wants to sell the

surplus asset, then the Valuer can value that surplus asset at

liquidation value.

ix. Intangible Assets

a. While valuing redundant fixed assets may be challenging

because of their intangibility, the Valuer should identify whether

there are potential buyers, licenses of intangible assets and

estimate what the owner would likely have to pay if he did not

own the patents/license.

Valuation of Non-Operating Assets

i. Once the non-operating assets are identified, the Valuer needs

to value them. However, if the Valuer is not an asset appraiser,

he/she/ it may engage a qualified appraiser to appraise real

estate or equipment, rely on management estimates of value

and/or if he is qualified value the assets himself.

ii. Where the Valuer relies on a management’s value estimates,

he/she/it should highlight this in valuation report (as an

assumption applied in the determination of value). Nevertheless,

the Valuer should undertake the necessary measures to assess

the reasonability of management’s estimates.

3.10.2

158

iii. The Valuer can compute the value of some non-operating

assets, such as portfolio of publicly listed investments by the

stock trading prices reported in the financial newspapers, or

through the assistance of a broker/investment bank, where the

holding is larger than a normal trading lot.

iv. On the other hand, working capital redundancies can be

confirmed through discussions with the Company’s Management

and banker(s), if required.

Control Premium & Discount for Lack of Control and Marketability

3.11

The income approach yields either a control level value or non-

control marketable value depending on the analysis conducted. For

example, if the valuation analysis requires the Valuer to place the

company on a non-control marketable level, then a discount for lack

of marketability (DLOM) may be required. On the contrary, the market

approach yields a non-controlling marketable value.

During the course of valuation engagement, the Valuer should

analyze the factors influencing the issue of minority versus control

and its impact on value as controlling and/or marketable interests

considered to have a greater value than a non-controlling non-

marketable interest.

3.11.1

3.11.2

3.11.4.1

159

Further, Control Premiums (sometimes referred to as Market

Participant Acquisition Premiums or MPAPs), Discounts for Lack of

Control (DLOC) may be applied to capture differences between the

Comparables, and the Company/Asset being valued, taking into

consideration the ability to make decisions and the changes that can

be made because of exercising control. Hence, MPAP and DLOC

are applied depending on the interest of the valuation subject the

Valuer is valuing, the control level being assumed, and the purpose

of the valuation.

Control premium

3.10.3

3.10.4

3.11.4.1 When assessing the control level, the Valuer should analyze the

following:

i. Degree of control elements that may not be present in any

specific ownership interest;

ii. Potential ability of a controlling shareholder to implement

policies that will enhance the value of control versus minority

shares. A non-exhaustive list of some of the rights of owner of

a controlling interest in a Company enjoys are as follows:

a. Appoint/ fire management and/or influence the decision

on management compensation;

b. Develop policies and introduce new measures to change

the business operations;

c. Acquire or liquidate assets/investments;

d. Select people with whom to do business and award

contracts.

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e. Declare and pay dividends; and

f. Change the articles of incorporation or by-laws; Block any of

the above actions.

3.11.4.2

3.11.4.3

Based on the above, it is apparent that the owner of a controlling

interest in a Company enjoys some valuable rights that a minority

owner does not have. In this respect, a majority shareholder,

with controlling interest is considered to have greater value than

a minority interest because of the purchaser’s ability to effect

changes in the overall business structure and to influence business

policies. Accordingly, a control premium should be applied if

using a market approach and the multiple selected represent a

minority interest.

“Control premium is defined as «the additional consideration that

an investor would pay over a marketable minority equity value

in order to own a controlling interest in the common stock of a

company.»

MPAP and DLCO can be quantified based on various method but

are generally obtained through the various studies conducted in

the US financial markets, which measures control premiums and

minority interest discounts or by comparing observed prices paid

for controlling interests in publicly-traded securities to the publicly-

traded price before such a transaction is announced. Examples

of such studies are MPAP Study and BVR Control Premium Study.

3.11.4.4

3.11.4.5

161

3.11.4.4

3.11.4.5

MPAP and DLCO can be quantified based on various method but

are generally obtained through the various studies conducted in

the US financial markets, which measures control premiums and

minority interest discounts or by comparing observed prices paid

for controlling interests in publicly-traded securities to the publicly-

traded price before such a transaction is announced. Examples

of such studies are MPAP Study and BVR Control Premium Study.

Control premiums differ depending on the following factors:

i. The nature and amount of non-operating assets;

ii. The nature and amount of discretionary expenses;

iii. The perceived quality of existing management;

iv. The nature and amount of business opportunities, which

are not currently being exploited; and

v. The ability to realize some synergies from the potential

investor’s existing business.

When valuing a non-controlling stake under the Income Approach

where the cash flows reflect the cash flows of a controlling interest,

the Value should apply a discount for lack of control should be

applied. The discount shall be calculated as follows:

Formula 12: Discount for Lack of Control

Calculate the liquidation value of Hassan Co. as at 31 December 2016 based on the following information:

DLOC =1- (/ 1] 1 + Control premium)]

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Discount for Lack of Marketability 3.11.5

3.11.5.1

3.11.5.2

The value of a company’s stock is worth less if it is not readily

marketable (i.e. easily convertible to cash) all else being equal. A

publicly listed company will be traded more frequently compared

to a non-listed company, which will take time to identify eligible

buyers and execute transactions.

Based on studies conducted in the United States, marketability

discount factors range from %15 to %60. The size of the marketability

discount depends on the following factors:

i. Frequency of dividend payments: A stock with low or no

dividends would typically have a higher lack of marketability

than one with high dividends. The holder of stocks that do not

distribute dividends is dependent 2on some future ability to sell

the stock to realize a return; i.e. the higher the dividend, the

lesser the dependence on a future sale to realize a return.

ii. Potential Buyers: The existence of buyers willing to purchase

the shares reduces the discount for lack of marketability.

iii. Size of Block: Smaller blocks of equity tend to have lower

discount for lack of marketability than larger ones.

iv. Profitability of the operations: Companies with higher profits

earned from operations tend to have lower discount for lack of

marketability than those with lower profits.

3.11.5.3

3.11.6.1

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3.11.5.3

3.11.6.1

v. Prospect of Public Offering or Sale of Company: The

discount for lack of marketability could be lower if there is a

possibility of a public offering. Conversely, the discount would

be higher if a company is planning to remain private

vi. Accessibility and reliability of information: The lack of

marketability discount depends on the level of information that

is or is not made available to minority shareholder and the

reliability of such information.

As the aforementioned are important and valuable rights that are

not typically attached to minority stake, a non-controlling discount

should apply when valuing minority interests. However, if a minority

shareholder can exert control as listed above, the purchase of

equity by the minority shareholder should be subject to a control

premium rather than a minority discount.

The primary method for valuing minority interests is referred to

as “Top down method”, which involves undertaking the following

three steps:

i. Estimating the equity value of a %100 interest.

ii. Computing the minority owner is pro rata interest through

dividing the equity value by the number of shares outstanding.

However, in cases where there are different classes of interests,

Valuing minority interests3.11.6

164

iii. Estimating the amount of premiums and discounts,

applicable to the pro rata value of the total enterprise, noting

the following:

a. The discounting from controlling interest value usually is

applied as a two-step process, first for minority interest and

subsequently for marketability, if and when applicable.

b. The discounts for minority interest and marketability

are multiplicative; i.e. no additive. Hence, the discount for

minority interest is taken first; then the discount for lack of

marketability is applied on the net amount after the minority

interest discount.

iv. When using Guideline Transaction method, if comparable

transaction values are for controlling stake or entire company,

multiples already reflect the control premiums and no additional

adjustment for controlling interest is necessary. However, the

value arrived from Guideline Transaction method may be

adjusted for the lack of private company marketability (DLOM)

depending on the purpose of valuation.

Example 14: Adjusted equity value after discounts

Calculate the adjusted value of Nojoom Co. as at 31 December 20XX after adjusting for discount for minority interest and discount for lack of marketability.

* Discounts represented below are illustrative purpose only. In some cases, courts will consider discounts in relation to each other.

165

167

Reporting4

168

General4.1

A valuation report is a document/communication, which must

effectively and clearly convey to client a clear understanding of

the valuation, as determined by the Valuer. It must give a precise,

accurate and clear description of the purpose and intended use

of valuation (including limitations on that use), scope of work, its

intended users, disclosure of sources of information, assumptions,

any special assumptions (as laid out in IVS (104 (2017, basis of Value,

para 8(200.4, significant uncertainty or limiting conditions having a

material or direct impact on valuation.

Objectivity, clarity and rationality of the valuation report is important,

as important decisions maybe taken based on it. The Valuer should

express any strong opinions about strengths or weaknesses of the

Valuation Subject in a reasoned way, ensuring that conclusions

reached is understandable by the reader9.

Depending on the business and business interests, additional

requirements may need to be reported upon, as per the International

Valuation Standards (IVS 2017 lay out such variations in their relevant

IVS Asset Standards8.)

4.1.1

4.1.2

4.1.3

4.2.1.1

4.2.2.1

4.2.1.2

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Forms of report4.2

IVS 2017 describes two types of reports8: (i) Valuation reports (ii)

Valuation review reports. For valuation reports, the IVS prescribes

nearly similar requirements as detailed in the previous sections of

the manual.

Types of valuation report

4.2.1

4.2.2

4.2.1.1

4.2.2.1

4.2.1.2

For valuation reports, the IVS requires details about the scope of

work, the valuation approach or approaches adopted, the valuation

method or methods applied, the key inputs and assumptions

used, along with the conclusion and the principal reasons for any

conclusion reached.

For valuation review reports, the IVS requires details about the

scope of review, valuation report being reviewed and its inputs

and assumptions as well as reviewer’s conclusion and the reasons

supporting it, apart from applicable content as stated above.

Reports can be delivered in ‘long form’ or ‘short form’. The type of

report required should be stated in engagement letter. In certain

exceptional situations, an oral presentation may be made of the

Valuer recommendation either to the client or to a third party, as

per the requirement of engagement. However, in such case, the

Board and/or Risk Management Leader should approve a copy

of the presentation (depending on the Valuer’s approval policy).

170

4.2.2.2

4.2.2.3

4.2.2.4

Draft reports are provided to clients, before issuance of a final

report. While normally, draft reports are superseded by final reports,

in some cases, draft reports may be the only deliverable required

by the client. The draft versions should be clearly marked as draft

(if possible, in each page/slide), so that it is not mistaken for a

final report. It should also add disclaimer that its reliance is limited,

and no parties can rely on it, as it is not finalized, and changes or

updates can be made to it.

A letter of representation from the Client must be obtained prior

to arriving at a conclusion and issuance of the final report to the

Client.

Care should be taken in case of oral reports, as information, which is

available in a full written report, may not be communicated through,

during the presentation. When communicating valuation results to

client orally, care should be taken to ensure that no statements are

made, which cannot be included in a full written report. There is

also a chance of misunderstanding and miscommunication, and

hence the usage of oral reports should be as limited as possible.

171

Contents of a valuation report4.3

The valuation report should provide sufficient information about the

Valuation Analysis, so that intended users can clearly understand

data, analysis, basis and value from the valuation.

The Valuation Analysis report should contain the following sections,

as applicable:

i. Letter of transmittal.

ii. Table of Contents.

iii. Introduction/Valuation Summary.

iv. Representation of Valuer/Statement of Limiting Conditions.

v. Valuation Analysis; and

vi. Abbreviations/Appendix and Exhibits.

The report must contain following information, as per IVS103:

i. Identification of client and who the report is being issued to.

ii. Purpose and intended use of valuation.

iii. Intended users of valuation.

iv. Scope of valuation.

v. Interest/Entity to be valued.

vi. Description of Interest/Entity.

vii. Valuation Date.

viii. Report date.

ix. Type of report.

x. Currency in which value is expressed.

4.3.1

4.3.2

4.3.3

172

xi. Name of the valuation firm and Valuer;

xii. Definition of basis of value (laid out in IVS 104);

xiii. Restrictions on use of the report;

xiv. Assumptions and limiting conditions;

xv. Description of material assumptions and their basis;

xvi. Sources of Information;

xvii. Extent of Valuer’s inspections/investigations;

xviii. Valuation approaches and methods considered;

xix. Valuation approaches and methods used;

xx. Financial statements and analysis;

xxi. Adjustments made;

xxii. Conclusions of value and reasons for conclusion reached;

xxiii. Limits or exclusion of limits of liabilities to parties

other than the client;

xxiv. Accounting standards followed; and

xxv. References of other documents (Engagement Letters)

maybe given to incorporate some of the content mentioned

above.

The report should contain the following information:

i. Appendices and exhibits, which include relevant workings.

ii. Background information of Valuation Subject. and

iii. Discussion of economic and industry outlook, especially

which may affect valuation.

173

A brief description for content in some of the sections of the report

are detailed below:

a. Letter of transmittal

i. This is the basic letter, which is addressed to the client/client

representative, and provides a basic overview of the whole

process. It lays out report date, Valuation Date, identity of

client, identity of interest to be valued, purpose of valuation (in

brief), definition/basis of value, restrictions in the usage of the

report and liability associated with it. It may also include the

nature and scope of services and application of jurisdictional

exception (if any), applicable premise and standard of value.

b. Introduction/Valuation Summary

i. This section provides a detailed summary of valuation, which

can be broken down into various sub sections as follows:

• Engagement and Company Background provides a

detailed explanation about identity of client, and any

relevant nonfinancial information about its relationship

with the subject entity of valuation. It also gives a

description of Valuation Subject.

• Purpose of Valuation gives details about the stated

usage and intended users of report, which may include

regulatory and legal purposes.

4.3.4

174

• Sources of Information subsection provides details about

the relevant sources of information, which were utilized

in performing the valuation. It may identify information

provided by management, which maybe in written form or

verbal, such as audited/unaudited financial statements,

financial projections, background information, and any

other information, which is provided through discussions,

emails or documents. It should further contain sources

utilized for finding relevant industry and economic

conditions, including publicly available information and

proprietary databases.

• Valuation Results compose of a brief overview of the

valuation analysis and provide results of the valuation. It

may also include tables/data to depict the same. It should

contain scope of work, summary of valuation tables and

a statement-providing conclusion of value, in a range or

a single value, clearly mentioning the currency.

• Matters of Emphasis gives information about any

major factors that guided the Valuer’s work during

the engagement. It also contains major assumptions,

valuation methodologies or information about future

actions provided by management, which are included. It

may also state inclusion/exclusion of interests, based on

scope of work.

175

ExampleAs informed by Management/Client, there are no contingent liabilities that are

expected to devolve or contingent assets, which are expected to realize with subject entity, as at the Valuation Date.

ExampleAnalysis, opinions and values given by Valuer are based on information provided by

client and the opinions are advisory in nature. It is not an opinion advising anybody to make a buy or sell decision.

• The valuation analysis and result are governed by concept of materiality. • We owe responsibility only to the client that has retained us and nobody else. • The valuation engagement has been performed in accordance with rules set by

Taqeem and International Valuation Standards. • The estimate of value contained herein are not intended to represent value of the

Company at any time other than the Valuation Date, as per the agreed scope of our engagement. Changes in market/industry conditions could result in opinions of value substantially different than those presented

c. Representation of Valuer/Statement of Limiting Conditions

i. This section provides representation by the Valuer of the extent

of the report. If Valuer relies on financial statements provided

by management, it shall include a disclosure, which highlights

that Valuer has not carried out any audit/due diligence on the

same. It might also state that any changes after the Valuation

Date, which have not been taken into account for the purpose

of valuation.

ii. It also layouts the extent of liability to third parties, be it of

legal nature or otherwise.

iii. states whether the Valuer is obligated to update the report.

iv. It should clearly state that the Valuer will have no responsibility

or liability for any losses occurred as a result of the circulation

or distribution of the report contrary to the report’s provisions.

v. It should also clearly state that review of historical Financial

statements does not constitute an audit of valuation subject.

176

a. Valuation Analysis

i. This section provides details about the actual workings done

in relation to valuation, which can be broken down into following

subsections:

a. Valuation Methodology provides description of the

valuation methodology and approaches considered; these

may include market approach, Income Approach, and Cost

Approach, based on nature of the valuation. It then lays

out the methodologies actually used, weights assigned to

each method used and provides the reasons behind the

applicability of the methods.

b. Financial Statement/Information Analysis provides

description about Valuation Subject being valued, and

assumptions, which have been incorporated (which might

not have figured in matters of emphasis). They contain key

historical and prospective financial information and analysis

for the Valuation Subject, such as profit and loss/ income

statement, balance sheet/statement of assets, graphs

related to important business variables, etc. For projected

financial information, underlying assumptions and basis

should also be included. They might also include other

information such as tax calculations, debt amortization

schedule, capital expenditure schedule, etc., as applicable.

ii. Valuation analysis section shall provide the workings of

valuation method/s performed on the Valuation subject. For

each approach, the following information:

177

a. For Income Approach/discounted cash flows method:

composition of revenue stream, methods and risk factors

considered in selecting appropriate discount rate and other

relevant factors shall be included;

b. For Asset Approach: adjustments made by Valuer to

the balance sheet, and how the assets value has been

calculated shall be calculated; and

c. For market approach: In case of Guideline Public Company

method, the selected guideline companies, process used in

their selection, rationale for pricing multiples used, how they

are used and if adjusted, the rationale for the same shall

be calculated. For Guideline Transaction method, rationale

for selecting transactions and associated pricing multiples

used, their usage, and if adjusted, rationale for the same.

iii. The section further contains exhibits of the workings,

including data sheets, calculations etc. for each method

utilized, for each entity/interest being valued.

iv. Conclusion of Value section shall contain final workings on

the valuation, summarizing all the values by various methods

used, and adjusting them, if required along with rationale.

This will depict the final value reached for the entity (in the

appropriate currency).

Refer to Appendix K for the sample of contents in a detailed report

178

Short Form Report/Presentation 4.4

A short form report should primarily provide a summary of key

information provided in detailed report; i.e. it does not contain the

same level of detail as in a detailed report. It should include the key

terms of valuation (including the Valuation Date, Valuation Subject

and basis of value) and the purpose for which the valuation is being

provided (including restrictions on the use of the report for other

purposes). The second section will express the Valuer opinion of the

market/investment or value’ without explanation or justification.

This report is primarily prepared for the use of senior executives

(Chief Executive Officer, Chief Financial Officer, etc.) and accordingly

includes key insights about the company, historical performance and

value conclusion; any required information, instrumental for the report

may be included in appendices such as representation of Valuer,

assumptions, etc.)

A short form report does not mean that less detailed valuation

analysis is undertaken, or the value is different from a detailed report.

The depth of qualitative information may be less, and sections (i.e.

market overview) may be excluded, depending on requirement of the

Client. A short form report may be issued as a standalone or can be

a deliverable with a full detailed report.

4.4.1

4.4.2

4.4.3

179

The risk/liability/responsibility of the Valuer does not change with the

type of report.

4.4.4

Refer to Appendix L for an example of a short form report

180

181

Engagement Closure

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Filing and archiving5.1

During the course of the valuation, the engagement team will receive

records (either by the personnel or the clients) most of which have to

be retained by the Valuer to comply with business, legal, regulatory

and financial requirements and/or for referencing purposes (to

support daily work, or during engagements in course of work as a

resource).

Valuer must maintain a principal record of information received from

his/her client, procedures performed, and valuation approaches

considered and used, and the value concluded.

The Valuer should dedicate a section on the sources of information

to list all the information obtained and analyzed in arriving at the

valuation conclusion.

A record is identified as all recorded information, which an

organization has created or received, for evidence of its operations

and have some value requiring its retention/maintenance for some

time. The records could be in multiple forms i.e. emails, work papers,

reports, faxes, letters, plans, correspondence and data from multiple

sources including photographs, videos, audio recordings, paper,

electronic, etc. The records can reside in file cabinets, computers,

databases, portable media (USB pen drive, DVD, smartphones),

network servers, etc.

5.1.1

5.1.2

5.1.3

5.1.4

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In valuation practice, records normally comprise of engagement

letters, correspondence for information, information provided by

client and other sources, workings, models, drafts, final reports,

documentation, forms for initiation and completion of engagements,

etc.

To ensure proper compliance and best standards, a comprehensive

record retention policy should be enacted. The policy should state

out a minimum retention period, where the records have to be

retained. A period of not less than seven years is globally considered

an acceptable practice for the same. However, senior management

(preferably belonging to Quality/Risk Management department)

maybe allowed to make exceptions, on a case-by-case basis.

It should be ensured that retention and deletion of records are in full

compliance with the policy of the firm, applicable regulations, laws

and professional standards. These policies will apply to records in

paper and electronic form, regardless of medium; be it flash drives,

hard disks, smartphones, social media, collaborative sites, files, etc.

and in any form text, video or audio.

Once the retention period has expired, and no applicable preservation

notices exist in relation to the records, the records can be deleted.

Records maintained after this should be periodically reviewed and

the need to retain them shall be re-examined.

5.1.5

5.1.6

5.1.7

5.1.8

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Security and confidentiality of all forms of information, related to the

valuation, is paramount. Appropriate measures must be taken to

ensure that information remain confidential; Paper records should

be stored in secured locations with limited and defined access and

records in electronic form need to be maintained as per the Valuer’s/

valuation firm’s information retention policy. Records may be kept at

on-site/off-site (though need to ensure that Valuer is able to access

the records if required); however, in case of third party offsite,

adequate measures should be enacted to ensure that the documents

are secured.

5.1.9

Closing instructions 5.2

At the completion of the engagement process, the following steps

should be followed:

i. A small summary/overview of engagement should be created

which can be used as a reference in the future internally (or

externally on anonymous basis), which in an M&A transaction may

be forwarded to external agencies (such as Bloomberg, Thomson

Reuters, etc.) where the valuation team/practice gets the credit for

the advisory/transaction undertaken. This also helps in pitching to

new clients for a similar engagement profile.

5.2.1

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iii. Clients should be asked about their satisfaction with regard to

the work undertaken and a system should be in place for receiving

and processing any feedback given by client.

The engagement team should ensure that they have followed all the

steps for engagement closure and a record of the same must be

kept. These include declarations that appropriate policies/laws were

followed and that engagement has been carried out properly.

A completion letter may also be enclosed with the final deliverable.

This letter is primarily used as a formal communication on longer

duration, phased engagements that may or may not include a formal

report; and

The engagement team can take advantage of this as an opportunity

to propose actions for follow-on services, meetings or events for

continued client interaction and where value addition is provided.

5.2.2

5.2.3

5.2.4

Refer to Appendix M and N for sample Completion Letter and sample Engagement Completion Checklist

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Managing repeat instructions5.3

The following procedures should be enacted, if client or a third party

reverts on the engagement.

i. If the client requires report for additional members, outside those

mentioned in the report as intended users, a release letter would be

created. This letter states the new intended user and purpose, and

the report is then cleared for dissemination to additional members.

ii. The Valuer should ensure that the report is appropriate for the

new users, by assessing the required usage, and should not

permit the distribution of the report if its usage is contrary to the

valuation undertaken.

iii. The Valuer should add a key clause stating that there will

be no responsibility or liability for losses occurred as the result

of circulation or distribution of the report contrary to the report’s

provisions.

iv. While signing release letter, care should be taken that it does not

expose the firm to any additional legal or risk liabilities, obligations.

5.3.1

Refer to Appendix O for sample Release Letter

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Complaints handling procedure5.4

For any complaints emanating, procedures on a firm wide basis

needs to be implemented.

A usual way to reduce complaints is to share a draft report before

sharing the final one with the client and taking their feedback. Any

issues raised can be addressed based on the assumptions and

explanation of workings.

After closure, if there are complaints about valuation analysis then

such issues can be resolved amicably; however, if the client refused

to resolve them amicably and/or wishes to escalate such complaints,

both parties should comply with the dispute resolution procedures

as per the Valuer’s dispute resolution handling procedures.

5.4.1

5.4.2

5.4.3

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189

Appendices

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Appendix A: Taqeem’s code of ethics6.1

Introduction

The Saudi Authority for Accredited Valuers «Taqeem» is the entity

responsible for setting standards and controls necessary for

valuation activities of real estate, economic entities, machinery

and equipment and the like in accordance with the Accredited

Valuers Law issued pursuant to Royal Decree no. (m/43), dated

(1433/07/09H). Taqeem aims to promote valuation profession,

improve proficiency of Valuers, set general provisions for

memberships and organize continuous professional education

courses to raise its members› performance to the highest level

and in accordance with the international standards. Taqeem is a

non-profit corporate body that has an independent budget and

operates under the supervision of Ministry of Commerce and

Investment.

The Saudi Authority for Accredited Valuers emphasizes the

importance of professional conduct on valuation and is committed

to set and maintain «The Code of Ethics and Conduct for the

Valuation Profession» which contributes to the development of

valuation profession and consolidates public trust.

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Scope of Code

i. Compliance with laws and regulations and application of

standards are achieved by adherence to this Code. Therefore,

all Valuers licensed by the Authority to practice valuation whether

temporarily until their approval issues or currently accredited

members, natural or corporate persons must comply with this

Code. The Valuer shall also require compliance with this Code

from his subordinates or associates throughout the valuation

process.

ii. When conducting any valuation service, this Code applies to

all internal and external Valuers as well as Valuers exempted

from the Law. The Code also applies to all valuation, review and

consultation services and to all sectors of valuation included in

the Law which are; real estate, economic entities, machinery

and equipment and the like. Furthermore, the Code applies to

all active, associate, honorary and student members once they

become members at the Authority as specified by the Law and

implementing regulations.

iii. All Valuers shall comply with the general provisions of this

Code and pursue its aims and objectives, realize the scope of

its application and the dimensions of the process and related

parties of the valuation profession. Valuers shall meet valuation

and Valuer›s requirements as well as follow the fundamental

principles and ethical behavior of the Code at all times and in all

transactions with related parties.

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The Aim of this Code

Developing the valuation profession and maintaining continuous

and constant improvement:

This Code does not only positively affect the clients and other

beneficiaries trust in valuation services, but also extends its effect

to include the public trust in the valuation profession. To achieve

such a result, it requires all members to work on achieving the

following objectives:

i. Uphold public interest: Always act in a way that upholds the

public interest.

i. Gain Public Trust: Strive relentlessly to gain and maintain

public trust.

ii. Members of the Authority must realize that acting in the

public interest involves having regard to the legitimate interests

of clients, government, financial institutions, employers,

employees, investors, the business and financial community

and others who rely upon the objectivity and integrity of the

valuation profession to support the public interest and orderly

functioning of the market.

iii. The public interest includes reasonable and informed

professional decisions which have greater influence on third

parties.

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iv. Pride in the profession and performance quality: Achieving

these aims requires all members of the Authority to provide high

quality valuation services demonstrating full commitment to the

professional level that is consistent with the fundamental principles

of the Code.

General Provisions

i. All members of the Authority must comply with all laws and

regulations applicable in the Kingdom of Saudi Arabia.

ii. Valuation practitioners shall acknowledge and recognize this

Code and all its aims, principles and provisions set forth therein

and commit to it as soon as they join the Authority›s membership.

iii. The Valuer shall be responsible for his associates, advisers

or employees’ commitment to all principles, provisions and

requirements of this Code.

iv. Members shall not prepare or participate in a valuation service

that violates the laws, regulations or complementary decisions of

this Code.

v. The Valuer shall report any unprofessional or unethical behavior

or any breach of the provisions of this Code.

vi. When a member is exposed to any suspicious situations or

conditions not stated explicitly in the provisions of this Code,

the Valuer must refer the matter to the Authority to determine the

procedures to be followed.

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vii. A valuation practitioner must meet the requirements of the

Accredited Valuers Law and its implementing regulations and be

an active member in the Saudi Authority for Accredited Valuers. The

Valuer shall employ authorized techniques accurately to provide

credible services, continue training in continuous professional

education courses and follow all the requirements of this Code.

It is necessary to ensure the integrity of the valuation process by

providing the users of valuation services with Valuers that have the

right experience, skill and judgment.

viii. The Valuer shall comply with the ethical and professional

principles. These include fairness, impartial judgments that are

not subject to any pressure and experience in valuing the subject

asset. The Valuer shall be knowledgeable about the characteristics

of the subject, the rules and procedures of valuation and have no

direct or indirect interest in the subject asset.

ix. The Valuer shall refrain immediately from any valuation process

or consultation for public or private entities, especially judicial

authorities and financial institutions, for any asset in which the

Valuer has a direct or indirect interest and to disclose clearly the

state of his ownership or the ownership of his relatives (to the third

degree) of any assets associated with or affected by the value of

subject assets.

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Fundamental Principles:

Article (1): Integrity:

1. A Valuer shall be straightforward and honest in all professional

and business relationships.

2. The Valuer shall not allow bias, conflict of interest or undue

influence of others to override professional or business

judgments.

3. The Valuer must be content and abstain from self-desires

and avoid doubtful matters, as he must «give up what is

doubtful for that which is not doubtful». The Valuer might hold

for something permissible for fear of falling into that which is

prohibited.

4. The Valuer shall not knowingly be associated with reports,

returns, communications or other information where the Valuer

believes that the information:

a. Contains false, misleading or biased information, analyses

or results.

b. Withhold or omit required information that might lead to

misleading results.

5. When the Valuer becomes aware that he has been associated

with such information, he shall take the necessary steps to be

disassociated from that information. For example, he may issue

a modified version of the valuation or report.

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6. In marketing and promoting themselves and their work,

Valuers shall be honest and truthful and not:

a. Make exaggerated claims about the qualifications they

possess, experience they have gained or neglect correcting

such claims.

b. Use incorrect or misleading information or exaggerated

declarations for services they provide.

c. Make disparaging references or unsubstantiated

comparisons to the work of others.

7. The Valuer shall not conduct his job in a way that leads to

error.

8. The Valuer shall not be involved in providing valuation

services that the majority of Valuers refuse for logical reasons.

9. The Valuer must act consistently in a way that emphasizes

his compliance with the applicable and related regulations and

legislation.

10. The Valuer must avoid any action that a reasonable

and informed third party would likely to conclude that it

adversely affects the Valuer›s integrity and compromises his

professionalism.

11. The Valuer shall not accept gifts, donations or unusual

exceptions before accepting the valuation assignment, during

the assignment or after its completion based on the result of

his work.

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Fundamental Principles:

Article (2): Independency:

1. The Valuer shall not compromise his professional or business

judgment because of bias, conflict of interest or the undue

influence of others.

2. The Valuer shall not to act for two or more parties in the same

matter without a written consent from both parties.

3. The Valuer must take all necessary precautions to prevent

the emergence of conflict of interests between the interests of

his clients.

4. When valuating a subject, the Valuer shall take all the

necessary precautions to ensure that there is no direct or

indirect interest for him, his company, his relatives, his friends

or his partners in the subject asset. Indirect interest includes

everything that the subject asset affects. When there is such a

conflict, the Valuer must disclose this information.

5. The Valuer must disclose his state as an internal or external

independent Valuer.

6. The Valuer must disclose the potential conflicts in writing

before accepting the assignment or later conflicts that the

Valuer discovers at a later date.

7. The Valuer must disclose conflicts discovered after the

completion of the valuation immediately after discovering those

conflicts.

8. The Valuer shall execute each assignment independently

and impartiality without regard to personal interests.

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9. When valuing a subject, the Valuer must not let personal

preferences affect the valuation.

10. The Valuer shall not accept a valuation assignment or

prepare any valuation that involves a predetermined or pre-

planned opinions or views.

11. Valuation fees must not depend on the results. For example,

the fee is a percentage of the total value of the subject asset or

it will be paid after the execution of the transaction.

12. The Valuer shall not accept an assignment based on

assumptions unlikely to be achieved in a time span logically

consistent with those assumptions.

13. Assumptions must be logical, for example, valuing a

land as decontaminated, provided that the assumption is

accompanied by a study on its possibility and the value if it

cannot be achieved.

14 .The Valuer shall not use or rely on unsubstantiated

conclusions or conclusions built on basis of prejudice of any

kind or conclusions that reflect a prejudiced opinion the report

relies on or increases its value.

15. The Valuer must work with various clients and not depend

totally on a limited number of clients which threatens his

objectivity.

16. When a Valuer reviews a report prepared by another Valuer,

as in security lending or other purposes, the Valuer must always

be impartial, make fair judgments and justify the reasons for his

agreement or disagreement with the report›s conclusions.

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Article (3): Competence:

1. The Valuer must ensure that clients or employers receive

competent professional service.

2. Valuation shall not be practiced by persons who do not apply

to the definition of «Valuer» contained in this Code and those

who do not meet the conditions and requirements.

3. The Valuer must be certain that he possesses the professional

knowledge and skills required to ensure competent professional

service.

4. Valuers must act diligently in accordance with applicable

technical and professional standards when providing

professional services.

5. The Valuer must exercise sound judgment and skills in

applying professional knowledge and performing such service.

6. Maintaining professional competence requires continuous

awareness and understanding of relevant technical,

professional and business developments. Continuing

professional development enables the Valuer to develop and

maintain capabilities to perform work competently.

7. The Valuer shall take reasonable procedures to ensure that

those working under his authority are at professional level and

have appropriate training and supervision.

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8. Where appropriate, the Valuer must be aware of his

limitations. If the Valuer does not have sufficient professional

knowledge and experience to carry out the valuation service or

does not have the ability to acquire it before the job is done, he

must require assistance of someone experienced in this type

of assignment or withdraw from the assignment altogether.

Article (4): Professional Behavior:

The Valuer shall commit to working with professionalism and

diligence and present work in a timely manner in accordance

with the regulatory requirements and applicable technical and

professional standards and avoid any actions that discredit

the profession. These includes;

A.Accepting Assignments: Before accepting any assignment

or engagement, the Valuer must:

i. Understand the dimensions of the required assignment;

this includes identifying the parties involved in the

assignment, the subject asset, the purpose of the

assignment and the basis of value, to agree with the client

on the scope of work.

ii. Ensure that the scope of work is sufficient to achieve

credible results.

iii. Ensure that the assignment does not pose any threats

to compliance with this Code, if any, the Valuer must use

safeguards to eliminate or reduce the threats.

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iv. Receive precise instructions from the client and

document them in writing in accordance with the International

Valuation Standards before engagement to avoid any

misinterpretation of meanings or scope of work. The Valuer shall

refuse any assignment that does not meet the abovementioned

points. If the Valuer accepts an assignment then later discovers

a threat to compliance with the principles of this Code, he shall

disclose this to the client and determine how to deal with the

assignment.

There might be cases when the Valuer withdraws from the

assignment after accepting it. The Valuer must not accept

an assignment if the circumstances do not permit achieving

accurate and reliable high-quality results. This usually leads to

the disappointment the client and the Valuer alike and affects

the reputation of the profession.

B. External sources:

i. When recruiting the help of third parties to complete

set of skills needed in the valuation assignment, the Valuer

must conform that the required skills and ethical principles

are applicable.

ii. The Valuer must obtain the consent of the client when

requiring the help of external sources. The third party

should disclose the identity of the assistants and their roles

in preparing the valuation report.

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iii. Contributions of each person shall be mentioned in the

report as well as how the Valuer used the information that

they have provided in the valuation report. This helps the

client to understand the role of each person and reduce

confusion.

C. Efficiency and Diligence:

i. The Valuer must work effectively to execute the client’s

instructions and notify them regularly about the assignment

developments.

ii. The Valuer must work according to the requirements of

the assignment carefully, diligently and in a timely manner.

iii. The Valuer must work hard to provide the best services

for clients and exercise due care to ensure that the provided

service is in accordance with all applicable professional

and technical regulations and standards of the valuation

subject, the purpose of the valuation or both.

iv. The Valuer must treat clients and the public with

courtesy and respond quickly and effectively to reasonable

instructions and complaints.

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D. Confidentiality:

i. The Valuer must handle the client›s information sensitively

all times and must not disclose confidential information or

results relevant to an assignment for or would be beneficial

to, another party or person.

ii. The Valuer shall not use confidential information gained

as a result of professional relationships for the personal

advantage of the Valuer or third parties.

iii. The Valuer shall maintain confidentiality of information

disclosed by a prospective client or employer.

iv. The Valuer shall maintain confidentiality of information

within the firm or employing organization.

v. The Valuer shall maintain confidentiality within his social

environment and be alert to the possibility of inadvertent

disclosure, particularly to business colleagues or family

members.

vi. The Valuer shall take reasonable procedures to ensure

that staff under his control and persons from whom

advice and assistance is obtained respect the principle of

confidentiality.

vii. The Valuer shall comply with the principle of

confidentiality even after the end of relationships between

the Valuer and the client or employer.

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E. Disclosure:

Disclosure is essential for valuation users to understand

the major issues and ensure that the valuation report is not

misleading. However, disclosure alone is not sufficient to

meet ethical standards. Without prejudice to the principle

of confidentiality, the following are circumstances where

Valuers are or may be required to disclose confidential

information or when such disclosure may be appropriate:

i. Disclosure is permitted or authorized by the client or

the employer;

ii. Disclosure is permitted by law.

iii. Disclosure is required by law, for example:

• Production of documents or other provision of

evidence in the course of legal proceedings; or

• Disclosure to the appropriate public authorities

regarding infringements of the law that come to light;

and

iv. There is a professional duty or right to disclose, for

example:

• To comply with the quality review by the Saudi

Authority for Accredited Valuers,

• To respond to an inquiry or investigation by the

Authority,

• To respond to the regulatory procedures in

accordance with the Authority such as disclosing to

the Violation Commission,

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• To protect the professional interests of a Valuer in

legal proceedings; or

• To comply with technical standards and ethical

requirements.

v. In deciding whether to disclose confidential information,

relevant factors to consider include:

• Whether the interests of all parties, including third

parties whose interests may be affected, could be

harmed if the client or employer consents to the

disclosure of information by the Valuer;

• Whether all the relevant information is known

and substantiated and when the situation involves

unsubstantiated facts, incomplete information or

unsubstantiated conclusions, professional judgment

shall be used in determining the type of disclosure to

be made, if any; and

• The type of communication that is expected, to whom

it is addressed and whether it is appropriate.

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F. Information and Documentation:

i. The Valuer must verify the data used in the valuation and

identify the extent of its reliability.

ii. When the Valuer receives information from the client,

he must reasonably verify and document the extent of

the client›s confidence in this information and ensure its

accuracy.

iii. The Valuer shall not rely on information presented by

the client or any other party without verification of their

eligibility or source, unless the Valuer specifies the nature

and extent of the information as a restriction, i.e. a limit

imposed on the valuation.

iv. The Valuer must prepare a work file for each assignment.

The file shall contain a hard or soft copy of every written

report, correspondence, note and document in addition to

the information, data and procedures adequate to support

the Valuer›s opinion such as inquiries, inspections,

sources, methods, analyses and calculations.

v. Every file shall contain supporting information for the

Valuer›s work, even when the Valuer only provides a brief

report to the client.

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vi. The work file must be prepared in a way that someone

who does not have any previous relationship with the

assignment can determine the stages underpinning the

valuation process up until the conclusions, and this is the

main purpose of the work file.

vii. The Valuer shall keep the work file of each assignment

for at least ten years after its completion. If the assignment

includes litigation, counting years starts at the end of the

litigation, including appeals.

G. Guidelines:

Further guidelines shall be issued as appendices to this

Code. The guidelines shall provide assistance to the Valuer

and explain some of the general concepts or provide

examples of threats to complying with the Code. The

guidelines will address these threats because of the wide

range of relationships, circumstances and safeguards to

be taken into consideration to eliminate or reduce these

threats to an acceptable level. Guidelines on complaints

or disciplinary action for the violation of this Code shall be

provided and as a response to any new requirements for

the Valuers, market or clients.

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Appendix B:Implementing Regulations of Accredited Valuers Law

6.2

Chapter I: Definitions

Article (1):

The following terms shall have the meanings set forth below, unless

the context requires otherwise:

1. Ministry: The Ministry of Commerce and Investment.

2. Minister: The Minister of Commerce and Investment.

3. Taqeem: The Saudi Authority for Accredited Valuers

4. Council: Taqeem›s board of directors.

5. Profession: Business valuation.

6. Law: Accredited Valuers Law, issued by the Royal Decree

Number M/43 and dated 1433/07/9.

7. Regulations: Implementing Regulations for the Accredited

Valuers Law (Business sector).

8. Code: Taqeem›s Code of Ethics and Conduct for the Valuation

Profession.

9. Registry: The Registry where Taqeem-accredited valuers in the

Business sector are registered at the Ministry

10. Valuation standards: The standards approved by Taqeem.

11. Guidebook: Business valuation guidance that Taqeem issues

for enhancing the quality of valuation and raising the professional

competence of valuers.

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12. Business: Business entities or interests regardless of their

size, weather personal or corporate including assets and liabilities,

and intangible assets such as patents, trademarks, goodwill and

intellectual property.

13. Business Valuation: The act or process of determining the

value of various business entities or interests according to a

purpose and basis of value.

14. Accredited Valuer: Natural or legal persons authorized to

practice the valuation profession.

15. Subscriptions: The predetermined amount of money required

for membership designations, Firm Account and other services

provided by Taqeem.

16. Valuation firm: A place the Accredited Valuer takes as

headquarter for valuation operations and meets the regulatory

requirements whether it is an individual office or a professional

company.

17. Experience hours: The acquired hours of professional valuation

practice. The Guidebook shall determine the process of calculating

the hours. Equivalent hours shall be allocated to attend seminars,

conferences, workshops and other related valuation events.

18. Firm account: An online account created by an Accredited

Valuer in Taqeem›s Electronic System where the valuer uploads

a summary of valuation reports issued by the Valuation Firm.

This Account allows the user to calculate Experience Hours for

the Accredited Valuer and other valuers, associate and student

members affiliated to the Firm.

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19. Valuation report: The document issued by an Accredited

Valuer to the Client, which includes conclusion of value, adheres

to the Accredited Valuer requirements in the Law and Regulations

and complies with the adopted valuation standards.

20. Valuation summary: Online forms in Qima Portal the Accredited

Valuer uses to summarize valuation reports issued by the Valuation

Firm, it includes valuation information such as who participated in

the valuation assignment and the nature of their participation.

21. Client: The beneficiary of the valuation assignment whether a

natural or legal person.

22. Electronic systems: The online systems Taqeem utilizes to

regulate valuation practice, and it includes:

a) Qima Portal: An online portal that provides services to Taqeem

members where they can organize and document their work as

well as register their experience hours.

b) Any other system or means adopted by Taqeem to regulate

the profession.

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Chapter II: Memberships in Business Valuation Sector

Article (2):

2.1 Taqeem Business Valuation memberships shall be categorized

as follows:

A. Basic Membership:

First: Those exempted under Article 40 of the Law, and they

include the following designations:

1. Provisional member

2. Accredited member

Second: Holders of a university degree in any discipline, provided

they obtain the fellowship certification. This category includes the

following designation:

• Fellow Member

Third: Those exempted under Article (40) of the Law and passed

Taqeem›s qualification exams without obtaining the fellowship

certification. This category includes the following designations:

• Practitioner Member.

B. Associate Membership.

C. Student Membership.

D. Honorary Membership.

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2.2 The requirements for Memberships are as follows:

A. Basic Membership:

1. Provisional Member: A person who has met the following

requirements:

a) Presented evidence of Business valuation experience

before the Law came into effect.

b) Passed Taqeem courses, which include:

• BV 201-200.

• BV 202.

c) Met the requirements for the membership form and

completed all required documents.

d) Passed the interview.

e) Paid the membership subscription fee.

2. Accredited Member: A person who has met the following

requirements:

a) Acquired the Provisional Member designation

b) Passed Taqeem courses, which include:

• BV 203.

• BV 204.

c) Gained at least (1000) hours of verifiable experience

registered in the Firm Account, of which at least (500) hours

has been worked as a Provisional Valuer.

d) Paid the membership subscription fee.

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3. Fellow Member: a person who has met the following

requirements:

a) Acquired the Accredited Member designation, or the

Associate membership.

b) Passed the exams of Taqeem courses which include:

• BV 205 for Accredited Members.

• BV 205 & 204 ,203 for Associate Members.

c) Gained at least (1000) hours of verifiable experience

registered in the Firm Account, after acquiring the Accredited

Member designation. Associate members are required to

gain at least (2000) hours of verifiable experience registered

at the Firm Account -while being registered as a student or

an associate member- of which at least (1000) hours gained

after passing (BV 204 & 203) courses, and another (500) after

passing (BV 205).

d) Has a bachelor’s degree or its equivalent in accounting,

economics, finance, or similar scientific specializations at an

accredited university, unless exempted under article (40) of

the Law.

e) Paid the membership subscription fee.

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4. Practitioner member: a person who has met the following

requirements:

a) Presented an evidence of (20) years of valuation experience

before the Law came into effect.

b) Passed Taqeem exams -except Fellow exams- to qualify

the member for accreditation.

c) Paid the membership subscription fee.

B. Associate Membership:

Associate Member: a person who has met the following

requirements:

1. Has a bachelor’s degree or its equivalent in accounting,

economics, finance, or similar scientific specializations at an

accredited university.

2. Passed the exams of Taqeem courses which include:

• BV 201-200 courses.

• BV 202.

3. Paid the membership subscription fee.

C. Student Membership:

A Student Member designation will be granted to an applicant

who is:

1. Pursuing a Bachelor’s degree or its equivalent in

accounting, economics, finance, or a similar scientific

specialization at an accredited university.

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2. Paid the membership subscription fee.

D. Honorary membership:

An Honorary Member designation is granted by the Taqeem›s

Board of Directors to natural or legal persons in recognition for

their achievements or their services to the Business Valuation

profession.

2.3 All Basic Memberships in section (A) of paragraph 2.1

– except Practitioner Members- shall commit to meet the

requirements of Fellow Members by the end of the, original or

extended, period stipulated in Article (40) of the Law.

2.4 Taqeem shall develop the necessary criteria for the

equivalency of expertise and other accreditation programs

from local or international authorities to their counterpart

membership designations in this Regulation.

Article (3):

3.1 Taqeem grants each affiliated member, who has met all

membership requirements, a membership card containing the

member›s information, designation and expiration date.

3.2 Taqeem shall issue the necessary decisions to regulate

the membership renewal process and address any delay

thereof.

3.3 All members of Taqeem shall return the membership card

immediately upon the decision of membership cancellation.

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Chapter III: Valuation Practice and Licensing Conditions

Article (4):

An Accredited Valuer shall practice valuation according to the

following:

(1) Comply with the provisions of the Law, Regulations, Code of

Ethics, and Guidebook;

(2) Practice valuation though a Valuation Firm;

(3) Display the valuer›s information at the Firm›s main office

and other subsequent branches, if any, including the name of the

Accredited Member, license number, authorized sector and phone

number;

(4) Indicate the authorized sector and Basic Membership

designation when signing valuation reports;

(5) Create a Valuation firm account and pay the required

subscription for the service;

(6) Upload a Report Summary -on the Firm Account- for every

valuation issued by the Firm as well as register experience hours. The

summary shall provide details of who participated in the valuation

assignment and the percentage of the Accredited Valuer›s, and

other valuers -who have acquired Basic Memberships-, associate

members and students;

(7) All valuers at the Firm shall be active Basic Members and work

under the supervision and responsibility of the Accredited Member

according to legal written contracts;

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(8) All valuers at the Firm shall be of good behavior and conduct

and has not been convicted to a penalty or punishment of a crime

that is against integrity or honesty, unless rehabilitated;

(9) Taking into account the provisions, regulations and other

decisions related to the Saudi Labor Law, the Accredited Valuer

shall commit to have no less than %25 Saudi professionals in

the Firm who have basic membership, associate membership or

student membership of total valuers.

(10) Train associate and student members according to the

arrangements determined by Taqeem.

(11) Renew Taqeem membership and practice license before

its termination. This obligation is demanded by all partners if the

Accredited Member is a legal person.

(12) Ensure that the valuers at the Firm -who have a Basic

Membership- and trainees such as associate and student members

shall renew their Taqeem membership before its termination;

(13) Work according to the rules and instructions provided by

Taqeem;

(14) Notify Taqeem of the Firm›s address within (30) days of

obtaining a practice license as well as any change in the address

within a period not exceeding thirty (30) days. The notification shall

be via electronic systems or in writing;

(15) Use the approved electronic systems to regulate valuation

practice.

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(16)

A. An Accredited Member shall not accept a business valuation

assignment in any condition stipulated in the Code, especially

the following:

1. Valuing businesses that the valuer own, co-own, have an

interest in - directly or indirectly - as an intermediary, investor

or a financier for their ownership or leasehold.

2. Businesses in which the valuer is a relative, to the third

degree, of the founder or a member of the Board of Directors.

3. Businesses of companies where the valuer provides services

that conflict with one›s valuation of either of the assets, either

directly or indirectly;

4. Businesses of organizations in which the valuer has shares

of ownership during the period of valuation. If the valuer

accepts to undertake such a valuation, the shares shall be

disposed of before the valuation.

5. Businesses where the valuer is a partner of one the

employees, a senior partner, or a partner of the company itself.

6. Businesses owned by organizations where the valuer is an

administrator of an endowment or a guardian of patrimony.

7. Businesses that have commercial activities similar to the

activities of the Client where the Business Valuer is a member

of the Board of Directors, or the Board of Directors includes

any of the Business Valuer›s relatives to the third degree.

219

B. Before accepting the valuation assignment, the Accredited

Valuer shall ensure that all valuers participating in the valuation

assignment are adhering to paragraph (A) of this item and

replace who cannot commit to such conditions.

(17) The following procedures shall be followed when an Accredited

Valuer ceases to work, either temporarily or permanently for any

reason:

1. The Ministry and Taqeem shall be notified of the reasons and

the duration of the cessation within thirty (30) days following the

cessation.

2. Taqeem shall be notified of the assignments affected by

the cessation, as well as the procedures taken to preserve the

rights of clients and staff for the thirty (30) days following the

date of the cessation; and the steps to be taken to deal with the

consequences of the cessation.

3. If one partner ceases to work, the remaining partners of a

professional company shall amend the Company Contract in

accordance with the Law of Professional Companies. Taqeem

shall be notified of the steps taken to reassign the assignments

supervised by the departing partner to other partners.

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Article (5):

A Basic Member shall practice valuation according to the following:

(1) Comply with the provisions of the Law, Regulations, Code of

Ethics, and Guidebook.

(2) Practice valuation through a Business Valuation Firm via a

written contract. A Saudi Basic Member can work with more than

one Valuation Firm, but not exceeding two, according to the

following conditions:

a. The primary firm must consent to working for another firm.

b. Maintain confidentiality of assignments for each Firm, and

refrain from valuing the same property for more than one

Valuation Firm.

(3) Adhere to item (16) of Article (4) of this Regulation.

(4) Obtain a valid membership when working at the valuation

Firm.

(5) Use the approved electronic systems to regulate the valuation

practice.

(6) Work according to the rules and instructions provided by

Taqeem;

(7) Notify Taqeem of the Firm›s address within (30) days of

obtaining a practice license as well as any change in the address

within a period not exceeding thirty (30) days. The notification

shall be via electronic systems or in writing.

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Article (6):

In accordance with the provisions of paragraph (4) of Article (5) of

the Law, a person whose name is registered in the registry must

have practical experience in valuing Businesses as follows:

1. Certified practical experience demonstrating the skills and

knowledge gained by passing BV 203 – at minimum - of Taqeem›s

approved qualification programs.

2. Documented practical experience gained by obtaining the

Practitioner designation according to the conditions set out in

this Regulation.

Article (7):

7.1 Associate and Student Members can acquire hours of

experience by working at Valuation Firms.

7.2 A Student member is required to pass the qualifying course

determined by Taqeem prior to joining the training at the Valuation

Firm.

7.3 Associate and student members shall comply with the

provisions of Basic memberships in Article (5) when working for

Valuation Firms. In the case of violation of any provision, Article

(14) of this Regulation shall be applied.

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Chapter 4: Membership Fees and Services

Article (8):

8.1 Taqeem shall charge a fee for memberships, examinations,

training courses, course materials and other services.

8.2 Student members will be eligible to a %50 discount on all

abovementioned services in paragraph 8.1.

Chapter 5: Training and qualification

Article (9):

Taqeem shall develop, localize, and accredit Business valuation

training curricula, as well as organize the required training courses

to qualify the valuers of this sector.

Article (10):

Basic Members shall attend Continuing Professional Development

(CPD) programs as required by Taqeem periodically.

Chapter 6: Control and Quality Assurance

Article (11):

Subject to the provisions of Article (35) of the Law, Taqeem

shall establish appropriate procedures to monitor the quality

of professional performance and ensure that the profession of

Business valuation is conducted in accordance with the provisions

of the Law and Regulations.

223

Article (12):

The Accredited Valuer shall commit to enable Taqeem or its

representative to monitor the quality of professional performance.

Chapter 7: Violations and Penalties

Article (13):

The Accredited Valuer shall be subject to Article (32) of the Law,

in case of any violation of the provisions of the Law or Regulations.

Article (14):

14.1 Without prejudice to the liability of Accredited Valuer for the

valuers under their Firm who have basic memberships, Taqeem

shall, in case of violation of any of the provisions of the Regulations,

carry out the following:

1) Notify the Basic Member of any breach thereof and inform the

Accredited Valuer who supervises their work of such violations

2) If the Basic Member›s violation is repeated or the act is contrary

to the principle of good conduct, the Council or its representative

may issue a decision to cancel their Taqeem membership.

14.2 The Basic Member shall be notified of the decisions issued via

electronic systems or registered letters, and the Accredited Valuer

who supervises their works shall be provided with a copy thereof

via abovementioned means.

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Chapter 8: General Provisions

Article (15):

15.1 According to Article (7) of the Law, the Valuers Registration

Committee shall set forth the rules governing its work, which shall

be issued pursuant to a decision by the Minister.

15.2 The Committee for Disputes and Violations- as provided for in

Article (34) of the Law - shall set the rules governing its work and

shall be issued by a decision by the Minister.

Article (16):

Members of other professional bodies are entitled to attend

specialized courses and enter exams held by Taqeem as well as

obtain Taqeem memberships.

Article (17):

Taqeem shall issue the necessary decisions to regulate provisions

of the Firm Account.

Article (18):

Taqeem shall interpret this Regulation and it shall be legally binding.

Chapter 9: Issuance and Effective Date

Article (19):

This Regulation shall be issued pursuant to a decision by the

Minister and shall be effective on its date of issuance.

225

Appendix C:Sample Client and Engagement acceptance form

6.3

Client Acceptance Questionnaire

1. Risk Questions

1.1. Identification

1.1.1. Is your proposed client an individual?

1.1.2. Is the client (or any of its affiliates) in any of the restricted

industries?

a) Yes

b) No

1.1.3. Do any of the following high-profile criteria apply to your

client? (Select all that apply.)

a) The client, its owners/directors/officers or its industry,

are at the center of public attention and appear regularly

in the media.

b) The client’s industry is currently the focus of stricter

regulation and / or investigation than normal.

c) Association with the client could subject Valuation Firm

or our work product to an unusual level of public attention.

d) It is a government entity or other statutory body.

e) …………..

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1.2. Integrity and reputation

1.2.1. Identify the current key officers, directors and significant

stakeholders of the entity (i.e., of the entity being evaluated,

not the parent entity).

1.2.2. What has been done to assess the client’s integrity and

reputation?

1.2.3. Based upon procedures performed per the preceding

question, and/or upon information known to you, are you aware

of any of the following risk factors? (Select all that apply.)

a) Concerns about the corporate governance of the client

b) Concerns about the management’s track record in this

or other business undertakings

c) Concerns about the integrity or reputation of the client

or its management

d) Concerns about illegal or unethical activities of the

client

e) ………………………..

2. Independence Questions

2.1. Independence Questions

2.1.1. Is Valuation Firm required to be independent of the

entity being evaluated?

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Engagement Acceptance Questionnaire

1. General Questions

1.1. Scoping

1.1.1. Is the output of this service likely to be used to originate

or resolve a dispute with another party (other than tax

authorities) that could involve litigation/arbitration?

1.1.2. Is the client or third party or counter party to the potential

conflict a governmental entity or a quasi-governmental

entity (including a state and local economic development

organization, or a local regulator)?

1.1.3. Could the output of this service be used by the client in a

hostile situation (e.g., a hostile takeover or hostile competitive

situation)?

1.1.4. Does this engagement relate to an underlying acquisition

or sale and is the name of the seller entity/individual known to

you?

1.1.5. Could this engagement contractually limit our ability to

work for other clients?

2. Independence Questions

2.1. Risk Management questions

2.1.1. Does the proposed engagement include Valuation

Firm’s involvement in any other services? (Applicable if the

Valuation Firm offers other services like audit/advisory services)

228

2.1.2. Does the proposed engagement include Valuation Firm’s

involvement with any assurance service other than financial

statement audits or reviews? (Applicable if the Valuation Firm

offers other services like audit/advisory services)

Appendix D: Liquidation Value – Potential Adjustments

6.4

1. If the Valuation Date coincides with the financial statement

date, the unadjusted net asset value on the financial statement

represents the equity value of the company.

2. Restate net current assets to net realizable value.

I. Cash, Bank and Term Deposits, which include accrued interest

on bank and term deposits. Early redemption penalties should

be accounted for if a forced liquidation is assumed.

II. Marketable Securities: Most recent or closing trading price

less brokerage fees should be used. If no trades have taken

place or if the investment holding represents more than a

normal trading lot, in which case either a blockage discount or

premium might be applicable, an investment banker should be

consulted.

III. Accounts and Advances Receivable, which includes all

accounts should be reviewed and evaluated on the basis that

the business being evaluated was in liquidation. Accounts that

would normally be collectible in full on a going concern basis

may become a problem in a liquidation situation.

229

IV. Inventories: In a liquidation situation, the Valuer may analyze

whether it is beneficial to maintain a sales force and warehouse

facilities until a substantial amount of inventory is sold or to bring

an auctioneer on board to dispose of the inventory. In notional

liquidation calculations, the highest write-downs typically made

for inventories.

V. Other Current Assets including prepaid expenses should

be reviewed individually since most of them may not have a

liquidation value at all.

them may not have a liquidation value at all.

3. Restate fixed assets to fair market value.

I. Land and Buildings: Real estate appraisers determine the

market value of land and buildings.

II. Machinery and Equipment: Capital Equipment appraisers

should be leased if the equipment and machinery are material

in amount. Dealers representing specialized equipment may

be consulted to obtain values relating to the product.

III. Furniture and Fixtures: Equipment appraisers should be

consulted if the furniture and fixtures are material in amount.

Net book value is typically used as an indicator of market value.

IV. Leasehold Improvements: Leasehold improvements are

normally reverted to the property owner and hence, do not have

value in a liquidation situation.

230

4. Restate other tangible and intangible assets.

V. Goodwill: Goodwill is not taken into account in a liquidation

situation on the premise that the business continuity ceases.

VI. Inter- Corporate Investments: Inter-corporate investments

should be individually valued on either a going concern or a

liquidation basis as applicable.

VII. Copyrights, Formulae, Franchises, Licenses, Patents,

Trademarks and Other Similar Contractual Rights: A fair market

value must be determined for the assets in cases where they

have any value to another party. Value relates to expected

stream of benefits from the assets. Normally, the discounted

cash flow method is used determine the value.

VIII. Deferred Charges: These charges have negligible market

value.

d. Re-state non-current liabilities at amounts outstanding

IX. Long-term Debt: Long-term debt balances outstanding at the

liquidation date should be used. The liability should be restated

at the discounted market value if the debt is assignable and

has a favorable rate of interest. However, if the face value is the

amount payable under liquidation scenario, then this amount

should be used.

X. Deferred Income Taxes (where applicable)

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These are considered a liquidation cost and are dealt with

below.

Contingencies: These are evaluated and quantified. Where

contingencies exist, reasonable care and effort must be

taken to quantify the liability and to determine the date of

settlement. The present value of the expected payment

should accordingly be computed. The recognition of

contingent assets or liabilities is often determined using

probabilities.

5. Liquidation costs are identified and quantified. They

include, amongst others:

a. Real Estate and Other Similar Fees: A provision should

be created for notional real estate commissions and related

costs of clearing title. Commissions may be on either an

exclusive or multiple listing basis. The size and nature of the

transaction will determine the rates. Provision should also be

accounted for notional commissions that would be payable

on the sale or auction of machinery, equipment, furniture

and fixtures.

b. Legal, Accounting and Other Similar Fees: Professional

fees associated with preparation of financial statements, tax

and zakat returns, legal/governmental documents, should

be estimated that are likely to be incurred if the business

were liquidated.

232

c. Termination Benefits to Discontinued Employees: If not

already accrued, holiday pay should be calculated and any

potential liabilities arising from employees initiating legal

proceedings for terminating them without notice.

d. Penalties for Early Termination of Long-term

Commitments: Early retirement of debt and/or leases often,

result in penalties imposed. Relevant documents should be

reviewed to determine whether or not potential penalties

exist.

e. Net Operation Costs During Period of Liquidation:

Provision must be created for overhead and operating

costs during the period of liquidation. The most common

examples are the liquidator’s fee, rent and utilities, security

and interest on debt.

6. Taxes payable upon liquidation are calculated (where

applicable).

a. Zakat and Corporate income and/or capital gains

taxes that arise on the notional disposition of assets and

liquidation of liabilities. Items to be considered include:

i) Income gains and losses on disposition of liquidation

of current assets. Marketable securities may also give

rise to taxable capital gains or allowable capital losses.

ii) Recapture, terminal losses and taxable capital gains

on the disposition of fixed assets. Real estate and other

commissions reduce proceeds of disposition.

233

iii) Terminal losses and taxable capital gains on the

disposition of other tangible and intangible assets.

iv) Contingencies to the extent they are deductible for

income tax purposes (where applicable). It is assumed

that payment relating to contingencies is made during

the liquidation period.

iv) Contingencies to the extent they are deductible for

income tax purposes (where applicable). It is assumed

that payment relating to contingencies is made during

the liquidation period.

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Appendix E: Information requirement list – Business Valuation

6.5

We would require as much of the following information for the

purposes of our valuation of XYZ Limited, as possible. While

compiling this information we request you to ensure the following:

1. All financial and qualitative background information is

requested to be made available in a hard copy as well as in

digital/ soft form;

2. All spreadsheet related work may be done on Microsoft Excel

and text files may be prepared in Microsoft Word; and

3. The financial model for preparation of Profit and Loss (P/L),

Balance Sheet (B/S) and cash flows and tax calculation,

depreciation and debt schedules may be all linked together

and as far as possible, formulas and not hard coded figures

may be used in the cells. (Formulas help understand the origin

of the figure in the particular cell and also assist in running

sensitivities).

Qualitative background information

1. Background of the Company (brief note on all major milestones);

2. A note on the products and services offered and highlights of

their manufacturing and marketing processes;

3. Discussion on past performance trends in the business of the

Company;

4. Strength, Weakness, Opportunity and Threat (SWOT) analysis

of the Company and comparison with key listed competitors;

235

5. A brief write-up on the key intangible assets in the Company’s

business and the relative importance of these intangible assets;

6. Details on marketing and distribution network;

7. Summary of all key contractual commitments/obligations and

rights of the company; and

8. Future trends and prospects for the Company.

Industry information

1. A brief write-up on the products and a comparison of these with

those of competitor’s products;

2. A note on industry giving information about its characteristics,

market size, company’s market share, expected growth rate,

information on major players, and other relevant information; and

3. Comparison of company’s operating and financial performance

with those of its key competitors.

Financial and other information

1. Historical data

• Annual Reports (audited) for the all the accounting periods

since inception/ last 3 years;

• Quarterly financials for the last 12 quarters (if available);

• Valuation reports done in the past (fixed asset as well as

business valuation);

• Details of each product (both in terms of quantity and value)

also including discounts and commissions and gross margins

for each;

236

• Details on other sources of income, if any;

• Details of liability or contingent liability not provided for in the

accounts as of the Valuation Date. With respect to contingent

liabilities, pleases also provide details of all types of guarantees

given by the Company - name of party, whether related party,

purpose, amount as of Valuation Date, whether party is solvent

and expected to continue being solvent, etc.;

• Details of key customers such as - names, addresses, revenue

contribution from them over past years, margins on sales to

them, any material changes expected in above relationship,

any addition expected in the list of key customers, etc.;

• Details of the signed order book position of the Company as

of current date;

• Details of key suppliers such as - names, addresses, purchases

from them over past years, any material changes expected in

above relationship, any addition / deletion expected in the list

of key suppliers, etc.;

• Details of quarter wise and product wise changes (if any) in

capacity of company over last 12 quarters;

• Balance sheet of company as of Valuation Date and YTD

financials of company from last annual report date / audited

financials date to Valuation Date;

• Market value of the assets of the company (real estate, plant,

etc.) as of the Valuation Date, if no recent asset valuation has

been carried out then management estimates on their fair

market value should be provided;

237

• A write up on current status of capital work in progress /

capital expenditure plans of the company;

• Are there any idle or surplus assets? If so, a brief description

and their book value and Zakat/tax written down value as well

as market value as of Valuation Date;

• Age-wise analysis of receivables/sundry debtors;

• Details of any doubtful debts, loans and advances other than

those shown on the latest Balance Sheet; and

• Details of transactions between the Company and other group

companies (i.e. related party transactions).

2. Projections related information

• Any indications suggesting that foreseeable future (5-2 years)

business and financial performance will be notably different

from last 3-1 years’ performance;

• 5 years financial projections (starting from the Valuation Date)

and assumptions supporting the projections (with underlying

basis), such as

• Balance sheet, all line items;

• Sources of revenue – model wise sales volume and net

sales realizations;

• Raw material consumption norms, their prices, etc.;

• General and administrative expenses;

• Marketing and sales expenses;

• Working capital requirements;

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• Capital expenditure- incremental and maintenance;

• Miscellaneous income;

• Zakat/tax computation and tax calculation worksheets;

• Leased assets, if any;

• Debt schedule with rates of interest for each line of

borrowing. Any risk of lenders withdrawing these facilities

post-transaction;

• General economic assumptions including inflation,

currency depreciation vis-à-vis foreign currencies, tariff

levels, etc. and how these have been considered for making

projection; and

• An explanation of all significant and material variances

in assumptions to what has historically been recorded.

3. Taxation/Zakat related information

• Summary of current position as regards assessment,

liability and dues towards major taxes;

• If there are any brought forward losses, an analysis

thereof over business losses, unabsorbed depreciation,

unabsorbed investment allowance together with their year

wise break-up;

• Details of any appeals/case filed with respect to Zakat/

tax; and

• Any contingent liability because of Zakat/tax.

239

4. Other Information

• Details of any transactions in the shares or business of the

Company (as the case may be) during last 3 years other than

through Tadawul, Nomu and/or recognized stock markets in

similar markets; and

•Any special factor that should be considered in the Valuation.

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Appendix E: Information requirement list – Business Valuation

6.6

DISCLOSURE OF INTEREST OF HOLDINGS IN RELATION TO THE

RELEVANT ENGAGEMENT

Date: ______________

To

<Insert Engagement Lead/Partner>

Dear Sir,

I shall not communicate, provide or allow access to any Unpublished

Price Sensitive Information, relating to a client entity or its material

affiliates or securities listed or proposed to be listed, to any person

including other Insiders except where such communication is in

furtherance of legitimate purposes, performance of duties or discharge

of legal obligations. I hereby declare the following particulars of listed

securities or voting rights [held /change in the holding held] by me/us in

the client entity to the relevant Engagement or its material affiliates along

with my Immediate Relatives

Name of the

Holder

Registered

Folio/ Client’s

ID No.

Distinctive No’s No. of

Equity

Shares

Particulars of

Change

From To

Name of the

Immediate

Relatives

I confirm that during the term of the Relevant Engagement with the Firm neither I nor my Immediate Relatives will trade in any of the above securities.

Yours faithfully,(_________)

241

Appendix G:6.7

A. Conditions when Conflict of Interest occurs

In conducting any part of its business, Valuation Firm should avoid

conflicts of interest and any other activity that could possibly threaten

their objectivity, integrity, confidentiality or reputation. Conflicts of

interest can arise in client engagements as well as any situation in which

Valuation Firm enter into business relationships, including procurement,

acquisitions and alliances.

Types of Potential Conflicts of Interest

242

B. Sample Internal approval letter for potential conflict of interest

Insert Office

[DATE]

To: Regional Advisory Quality Leader and the Conflicts Director

cc: [Name] - Coordinating Partner for Engaging Client

[Name] - Coordinating Partner for Other Party Client

[If consulted – Names of Others Consulted]

[If applicable - Names of Other Internal Parties]

From: [Name] - Engagement Executive in Charge for Engaging

Client

Potential Conflict of Interest Memorandum

[Engaging Client]/[Other Party Client]

Prior to accepting any engagement, Firm guidance requires the

completion of our assessment as to whether we have a potential conflict

of interest. At the beginning of this process, we assess whether two or

more clients have potentially differing, or possibly adverse, interests that

may be affected directly by services the Firm has provided, or is being

asked to provide, to one or more clients. In this regard, we analyze the

client relationships and the nature of the services and conclude whether

a potential conflict of interest exists.

243

As a result of completing this process with respect to the potential

engagement with [Engaging Client], we have noted that a potential

conflict of interest may exist between [Engaging Client] and [Other Party

Client] that we believe should be disclosed to [Engaging Client] and [Other

Party Client]. We have concluded we can perform this engagement

with objectivity as required by professional standards. Each client must

acknowledge this potential conflict and consent to Valuation Firm’s

involvement in the engagement before we will accept this engagement

for performing the [Service(s)].

[Note to Preparer: The preparer should describe the proposed service(s)

in the following paragraph in sufficient detail and document the nature of

the potential conflict of interest and the necessary actions to mitigate or

reduce the risk to a manageable level, to enable the Regional Advisory

Quality Leader to make an informed decision as to whether or not we

should perform such services.]

Summary of Proposed Services and Clients:

[Engaging Client], a [specify work performed by the Valuation

Firm] [public] client of the valuation firm [Practice and Local Office

1] has asked us to perform [describe the nature of the services

giving rise to the potential conflict of interest] involving [Other Party

Client]. [Describe how services affect Other Party Client]. The

Valuation Firm has also performed [choose one or more:] [audit

services] [tax services] [advisory services] [etc.] for the Engaging

Client during the past three years and [name of the Coordinating

Partner] is the coordinating partner.

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[Other Party Client] is [public] client of the Valuation Firm’s [Practice

and Local Office 2] and [Other Party Client Coordinating Partner] is the

coordinating partner. The Valuation Firm has performed [choose one or

more:] [audit services] [tax services] [advisory services] [etc.] for [Other

Party Client] during the past three years.

The _________________ services will be performed by a team led by

[name of Engaging Client Engagement Executive in Charge]. None of the

Engaging Client engagement team members has provided any services

to [Other Party Client] during the past three years. It is our intention that

[name of Engaging Client Engagement Executive in Charge] will serve

as the engagement Executive in Charge and that the other primary

professionals assigned to the engagement will be [name senior members

of the team].

Summary of Mitigating Actions

The necessary actions to mitigate or reduce the risk to a manageable

level are described herein: [Describe the necessary actions provided by

the conflicts team]

Summary of Parties Informed

[Describe any other relevant, non-confidential information relating to the

transaction or engagement.]

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[Engaging Client Engagement Executive in Charge] has consulted

with [Engaging Client Coordinating Partner] and [Other Party Client

Coordinating Partner] [and Names of Others Consulted, if any] who

concurred with the Firm’s undertaking of this proposed engagement for

[Engaging Client] under these circumstances. These individuals are

copied on this memo as evidence of their concurrence.

As part of the engagement acceptance process, we informed [Engaging

Client] of the potential conflict of interest (without breaching our

confidentiality obligations) and the need for notifying [Other Party Client]

that a written acknowledgement and consent letter will be required

documenting that management of both [Engaging Client] and [Other Party

Client] are aware of, and consent to, the Valuation Firm’s performance

of services for both [Engaging Client] and [Other Party Client]. We also

informed [Engaging Client] that such signed letter will be required before

we can accept [or proceed] with the engagement. A copy of the potential

conflict of interest acknowledgement and consent letter that [Engaging

Client] and [Other Party Client] will be asked to sign is attached. If

either [Engaging Client] or [Other Party Client] will not acknowledge and

consent to the potential conflict of interest, we will not proceed and the

engagement with [Engaging Client] will be declined.

Acknowledgement and Consent Letter status

There are no planned modifications to the acknowledgement and

consent letter to be signed by [Engaging Client] and [Other Party

Client] from our standard template [except as follows:]. Should

either of our clients request modification,

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the Valuation Firm will be promptly brought to your attention for

approval before accepting the engagement.

We will complete the internal approval process and obtain signed external

acknowledgement and consent letters prior to accepting the engagement

and starting fieldwork [if any exceptions are required, describe why].

Also, as part of the engagement execution process, we will establish and

observe appropriate confidentiality walls and comply with other policies

and requirements as set forth in the “Summary of Mitigating Actions”

section above, the Conflicts of Interest Global Policy and the supplemental

Advisory service line guidance.

This memorandum represents a request for your approval of our

participation in this engagement for [Engaging Client]. Please indicate

your approval by signing on the appropriate line below and returning a

copy to me.

___________________________________

Regional Advisory Quality Leader and Date

___________________________________

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Appendix H :Non-Disclosure Agreement Template

6.8

CONFIDENTIALITY and Non- Disclosure AGREEMENT

ABC Limited

Attention: Mr. XXXX XXXX

Address

Dear Sir,

Re: Valuation of certain identified assets / liabilities related to

acquisition of shares of ABC Ltd.

We (“XYZ”) write to confirm the terms of our agreement in respect

of the confidentiality and non-disclosure of the information you will

be making available to us.

You will be providing us with access to certain information, which

has been designated as confidential information, and which

relates to valuation of identified assets / liabilities related to

acquisition of shares of MNO (hereinafter referred to as “MNO”)

by ABC Limited (“ABC”). This information may be disclosed to us

either in writing, orally or by access to computer systems or data,

but will be clearly designated on its face or otherwise in writing by

you as being confidential (“the Information”). In consideration for

you granting this access to the Information, ABC agrees that:

1. Subject to Clause 6 below, we will keep the Information

strictly confidential and will not disclose it to any third party

(other than our staff) without your prior written consent;

XX XXX 20XX

248

2. The Information will only be disclosed to those personnel of

XYZ and members firms of the global network of XYZ firms who

need to know it for the proper performance of their duties in

relation to this project, and then only to the extent reasonably

necessary. XYZ will take appropriate steps to ensure that all

personnel to whom access to the Information is given are

aware of its confidentiality;

3. The Information disclosed to us will be used solely for the

purpose of valuation of identified assets / liabilities related to

acquisition of shares of MNO Ltd. (the “Purpose”);

4. XYZ will comply with the confidentiality obligations set out

herein for a period of twelve months from the date of disclosure;

5. On the termination of our involvement in the above project,

and upon being requested to do so, XYZ will return the

Information disclosed to it within a reasonable period, subject

to the retention of proper professional records;

6. The obligations contained above shall not apply to any

Information which:

a. is or becomes publicly available otherwise than through

a breach of this agreement;

b. is already in XYZ’s possession without any obligation of

confidentiality;

c. is obtained by XYZ from a third party without any obligation

of confidentiality;

d. is independently developed by XYZ outside the scope of

this agreement;

249

e. XYZ is required to disclose by any legal or professional

obligation or by order of a regulatory authority.

7. This Agreement shall terminate upon the earlier of (a)

the expiry of twelve months from the date hereof, or (b) the

execution of a definitive agreement between the parties in

furtherance of the Purpose; and

8. This Agreement shall be governed by and construed in

accordance with the laws of “country”.

We should be grateful if you would acknowledge your

agreement to these terms by signing the copy of this letter

where indicated and returning to us.

Yours faithfully

For XYZ

Name

Designation

We agree to the above terms regulating the disclosure of the

Information.

ABC Limited

By: ________________________________________________

Mr. Client Representative

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Appendix I: Sample of Engagement Letter6.9

ABC Limited

Attention: <<please provide>>

<<Address>>

Dear Sir,

Re: Report on Valuation of equity shares of ABC Limited

Thank you for choosing XYZ (“we” or “XYZ”) to perform professional

services (the “Services”) for ABC Limited (“you” or “the Client” or “the

Company” or “ABC”) relating to the valuation of its equity shares as at

XX XXX 20XX (“Valuation Date”).

(“Purpose”). We appreciate the opportunity to assist you and look

forward to working with you

The attached Statement of Work describes the scope of the Services, our

fees for the Services, and any additional arrangements. The Services

will be subject to the terms and conditions of this letter, together with

its attachments, including the General Terms and Conditions, the

applicable Statement of Work and any other Appendices (together, this

“Agreement”). This Agreement supersedes all discussions we have had

so far.

<<Intentionally left blank>>

Please sign this letter in the space provided below to indicate your

agreement with these arrangements and return it to undersigned at your

earliest convenience.

251

If you have any questions about any of these materials, please do not

hesitate to contact undersigned so that we can address any issues

you identify before we begin to provide the Services. From our side,

undersigned will have the overall responsibility for the engagement. We

understand that the undersigned would be the co-ordinator from your

side.

Very truly yours,

XYZ

AGREED:

ABC Limited

By: ________________________________________________

Authorized Signatory

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Enclosed:

Copy of this letter with all appendices for you to sign and return

Appendix A - Statement of work

Appendix B – Fee Proposal

Appendix C - General terms and conditions

STATEMENT OF WORK

Background

Background of appointing entity.

Background of valuation subject.

Purpose of valuation

Scope of our Services

The scope of our Services is to perform a valuation of ABC as at Valuation

Date for the aforementioned purpose.

Basis of valuation

For the purpose of the above valuation, the basis of value will be fair

value. Fair value means the price that would be received to sell an asset

or paid to transfer a liability in an orderly transaction between market

participants at the measurement date.

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Limitation of our scope

We will not, except to such extent as you request, and we agree in

writing, seek to verify or be responsible for the accuracy of the data

(including facts, estimates, opinions, projections, forecasts or other

information), information and explanations or arithmetical accuracy /

logical consistency thereof provided by yourselves, and you are solely

responsible for this data, information and explanations.

Our duties and responsibilities shall be limited to those expressly set

out in this letter and without limiting the generality of the foregoing, we

shall not:

Provide you with any accounting, legal, tax or other specialist advice

or assume any responsibility for or liability in respect of any advice given

to us or you by any other professional adviser;

Provide advice on any aspects relating to legal and regulatory

requirements in or outside India;

Assist you in the preparation of any business plan. Our role as regards

business plan shall be limited to carrying out a broad comparative

analysis vis-à-vis past information available including for comparable

companies;

Express any independent opinion on, or take responsibility for, the

achievability of any forecasts or the reasonableness of any assumptions

or upon the fairness or accuracy of any financial or other information

relating to the business;

254

Perform financial or other due diligence on you or undertake a

separate valuation of fixed or other assets (it would need to be provided

to us by you in case we believe that such a valuation analysis is important

for carrying out the current exercise); or

Evaluate the technical/operational product information which we are

not equipped to evaluate and for which we will rely on the information

provided by the management

Owe duty of care to any person other than you.

If you are not able to provide us with any of the information we have

requested, this may affect our ability to conclude our valuation in the

terms indicated above or at all. We will inform you of any restrictions

to our valuation or the reliance which may be placed on it because of

incomplete information.

We will not approach potential buyers/seller of the Company to test

their reaction to our valuation or, indeed, identify whether there are any

potential buyers or the size of population of buyers.

In no circumstances shall we be liable, other than in the event of our

bad faith or willful default, for any loss or damage, of whatsoever nature,

arising from information material to our work being withheld or concealed

from us or misrepresented to us by your directors, employees, or agents

or any other person of whom we may make inquiries, unless detection of

such withholding, concealment or misrepresentation should reasonably

have been expected because the fact of such withholding,

255

concealment or misrepresentation was evident without further inquiry

from the information provided to us or expressly required to be

considered by us pursuant to the scope of analysis agreed upon under

this letter. This clause, and any assessment of our work made pursuant

to it, will have regard to the limited scope of our analysis agreed under

this letter.

It may be noted that depending upon track record of your business

and of comparable market transactions/valuation parameters and

availability of sufficient reliable information thereon in public domain;

valuation analysis may be more or less subjective.

Circulation of the Report

The valuation Report will be provided to you for the above Purpose only

and should not be used or relied upon for any other purpose, nor should

it be disclosed to, or discussed with, any other party without our prior

consent in writing.

It may be clarified that results of valuation exercise can be different if

carried out for a purpose other than the Purpose for which the current

exercise has been undertaken. Accordingly, we would not be liable at

all for any loss arising due to use of our Report under this engagement

for any other purpose.

256

Timetable

We will mobilize our engagement team to commence work on the date of

execution of this Agreement or receipt of advance payment, whichever

is later (the “Start Date”). Throughout the course of the engagement,

we shall be in close discussions with you and keep you informed of the

progress of our work.

We will work towards submission of our draft Report within xxx weeks

from the Start Date and/or date of receipt of majority of data/information

required for the engagement, whichever is later. You acknowledge

that achieving our schedule is a function of numerous factors, many

of which are out of your control and Valuer’s control. Our timing will

also depend significantly upon the availability and the promptness with

which reliable and accurate information is made available to us. We

request you to review and provide us with your comments on the draft

Report within one week of the receipt of our draft Report. We would like

to issue the final Report within 15 days of issuing the draft Report. We

will issue the final Report only after the draft Report is approved by you.

If for some reason you request us to delay the issuance of final Report,

we will not issue the final Report until you request us to do the same.

However, if the Report needs to be updated at the time of issuance

of final Report on your advice as above, then we may undertake such

additional work subject to a fee charge separately for the extra efforts

involved in updating the Report. If no updating is involved, no extra fees

will be charged.

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Fees

Our professional fee of the engagement would be xxx.

a. In addition to the fees set out above all direct expenses and

disbursements (“Out of pocket expenses” or “OPE”) incurred in

connection with the performance of the services, and an administrative

surcharge, to be calculated as xxx% of the OPE.

b. Direct expenses include reasonable and customary out-of-pocket

expenses such as travel, meals, accommodation and other expenses

specifically related to the engagement. The administrative surcharge is

levied towards recovery of expenses such as printing and stationary,

telecommunication costs, other levies/taxes, costs that are not always

identifiable to specific engagements.

c. The above fee estimate is valid for work performed up to and

including issue of a draft final report, subject to minor amendments.

2B. Terms of payment

Payment is due upon receipt of XYZ’s invoice. In case the payment is

not made within 15 days, interest @ ___ % for the delay would become

due and payable along with the fees.

2C. Method of payment

All payments should be done through electronic transfer of funds or

through cheese or draft. Please intimate the details of specific invoice

against which the payment is made. Billing details

258

Bill addressed to

e-mail id for invoice submission

(more than one email id can be

given)

Address for physical invoice

submission, if required (not

required in case of digitally

signed invoices)

2D. Contact information

As mentioned below we have identified our contact person at XYZ and

similarly you have identified your contact person with whom we should

communicate about these Services

Particulars XYZ Ltd ABC Ltd

Engagement

manager

Billing and collection

TDS certificate

259

Our Responsibilities

We will provide the Services (or such variations as may subsequently

be agreed in writing between us) with reasonable skill and care and in

a timely manner. Emphasis during our valuation analysis is usually on

substance over form and on materiality than complete accuracy given

the nature of valuation discipline as well as purpose and context of most

valuation jobs. Also, it must be understood by you that you should not

omit any factor relevant and material for valuation analysis and that you

should check out relevance or materiality of any specific information to

the present exercise with us in case of any doubt. Our conclusions are

based on the information provided by you. It must also be understood

by you that any omissions, inaccuracies or misstatements on your part

may materially affect our valuation analysis/results. Accordingly, we

would assume no responsibility for any errors in the above information

furnished by you and their impact on the present exercise. In addition,

we assume no responsibility for technical information furnished by you

and believed to be reliable.

The nature and content of any advice we provide will necessarily reflect

the specific scope and limitations of our engagement, the amount

and accuracy of information provided to us and the timescale within

which the advice is required. If, at your request, we provide our advice

in an abbreviated format or timescale, you acknowledge that you will

not receive all the information you would have done had we provided

a full written Report or had more time in which to carry out the work.

Oral advice provided by anybody within XYZ with reference to this

engagement is not valid and must not be relied upon by you.

260

Written advice given by XYZ with reference to this engagement is valid

only if it is given by person signing this Agreement on behalf of XYZ or

by the authorized signatory of such person.

If general advice is provided, the applicability of this will depend on

the particular circumstances in which it is to be used by you (of which

we might not be aware) and should be viewed accordingly. In relation

to any particular transaction, specific advice should always be sought,

and all material information provided to us. Our advice is provided only

for the Purpose of this engagement and we disclaim any responsibility

for the use of our advice for a different purpose or in a different context.

We shall be under no obligation to update any advice for events

occurring after the advice has been provided in its final form.

Presentation of results

Our valuation analysis will be documented in a Report (in Microsoft

Word or Microsoft PowerPoint format) discussing our methodologies

and opinion(s), and including supporting exhibits, e.g. the key elements

of business plan to be provided by you. The opinions expressed in

our Report will be based on methods and techniques that we consider

appropriate under the circumstances. The Report will contain XYZ›s

Disclaimers and Declarations with respect to the Services. These

Disclaimers and Declarations shall form part of any written literature

drawing reference to our Report.

261

The opinion(s) rendered in the Report shall only represent the opinion(s)

of XYZ based upon information furnished by you and others on your

behalf and other sources and the said opinion(s) shall be considered

advisory in nature. Our opinion will however not be for advising anybody

to take buy or sell decision, for which specific opinion needs to be taken

from expert advisors.

It is clarified that only hard copy prints of the valuation model would be

provided to you and soft/digital copy of the same would not be provided

to you. Likewise, you retain all copyright and other intellectual property

rights in everything developed by you either before or during the course

of the engagement.

You recognize that, for the purposes of carrying out our responsibilities in

this engagement, we shall not be treated as having notice of information,

which may have been provided to individuals within this firm who are

not involved in this engagement. We may make reference to, as a part

of the brief factual description of the work done for you (transaction

tombstone, etc.), your corporate/brand name, trademark, logo, etc. in

our credentials, proposals, brochures and publicity materials, which

may be forwarded to prospective clients or such other parties as per

our needs.

262

Other matters

If at any time you would like to discuss with us how our service to you

could be improved, or if you are dissatisfied with the service you are

receiving, you may take the issue up with your usual partner contact.

If you prefer an alternative route, please contact [Name of Country

Managing Partner] at <Address>.

We undertake to look into any complaint carefully and promptly and to

do all we can to explain the position to you.

Very truly yours,

XYZ

AGREED:

ABC Limited

By: ________________________________________________

Authorized Signatory

263

Appendix J: Financial Statement Analysis- key ratios

6.10

Activity Analysis

A firm needs to invest in both short-term (inventory and accounts

receivable) and long term (property, plant and equipment) assets

in order to carry out operations. Activity ratios are financial analysis

tools used to gauge the ability of a business to convert various

asset, liability and capital accounts into cash or sales (also called

firm’s level of operations).

A higher ratio implies efficient firm operations as relatively fewer

assets are required to maintain a given level of operations.

Monitoring the trends in these ratios over time and inter firm

comparison in the industry can point out potential trouble spots or

opportunities. Although these ratios do not measure profitability

or liquidity directly, they are, ultimately, important factors affecting

those performance indicators.

A firm’s capital requirements, both operating and long term, can

be forecasted using activity ratios. Investments in additional

assets would be required to grow sales. Activity ratios enable the

Valuer to forecast these requirements and to measure the firm’s

ability to purchase the assets needed to sustain the forecasted

growth.

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Short-Term (Operating) Activity Ratios

i. Inventory turnover

The inventory turnover ratio provides an indicator of how efficiently the

firm is managing its inventory. A higher ratio is an indicator that inventory

does not deteriorate in warehouses or on the shelves but rather moves

quickly from time of acquisition to sale.

The inverse of this ratio can be used to calculate the average number of

days inventory is held until it is sold:

ii. Receivable turnover

The receivable turnover ratio and the average number of days

receivables are outstanding can be calculated as follows:

Inventory turnover=(Cost of goods sold)/(Average inventory)

Day sales of inventory=365/(Inventory turnover)

Receivables turnover=Sales/(Average receivables)

Days receivables outstanding=365/(Receivables turnover)

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These ratios measure the effectiveness of the company’s credit policies.

A high turnover ratio may indicate that the company’s collection is

efficient and that the company has high quality customers who pay off

debt quickly. On the other hand, a low ratio may indicate a conservative

collection policy, which may drive away potential business customers.

When calculating receivables turnover, care should be taken to include

only trade receivables, excluding receivables related to financing and

investment activities.

iii. Working capital turnover

The working capital turnover ratio is defined as a summary ratio used to

measure the amount of working capital needed to maintain a given level

of sales. A high working capital turnover indicates that management

is using the company’s short-term assets and liabilities efficiently to

support sales. In contrast, a low ratio shows that the management

is investing excessively in short term assets such as inventory. Only

operating items should be considered while computing this ratio. Short

term debt, marketable securities, and excess cash should be excluded.

Working capital turnover=Sales/(Average working capital)

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Long Term (Investment) Activity Ratios

i. Fixed asset turnover

The fixed asset turnover ratio measures the efficiency of (long-term)

capital investment. The ratio reflects the operating performance of the

fixed assets and measures how able a company is to generate net sales

from fixed asset investments.

An analyst must consider changes in the ratio over time as sales and

capacity increases may not be proportional. Sales growth is continuous,

albeit at varying rates. Changes in capacity to meet that sales growth,

however, are discrete, depending on the addition of new factories,

warehouses, stores and so forth. The combination of these factors,

results in a volatile turnover ratio.

The life cycle of a company or product includes a number of stages:

start-up, growth, maturity (steady state), and decline. The initial turnover

for start-up companies might be low, as their level of operations are

below their productive capacity. However, turnover will improve

gradually with growth in sales until the limits of the firm’s initial capacity

are reached. The increase in capital investment needed to maintain the

growth would have an impact on the ratio as sales growth is a gradual

process. This process will continue until the firm matures and its sales

and capacity level off and will eventually decline when the firm enters

its decline stage.

Fixed assets turnover=Sales/(Average fixed assets)

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Problems may arise because of the timing of a firm’s purchase of

assets. Two firms with similar operating efficiencies, having the same

productive capacity and the same level of sales, may show differing

ratios depending on when their assets were acquired. The firm with

highly depreciated assets would show a higher turnover ratio, as the

carrying value of that firm’s assets would be lower. Similarly, for any firm,

the accumulation of depreciation expense would result in a biased ratio

(accumulated would be faster if the firm uses accelerated depreciated

methods or short depreciable lives) if actual efficiency did not change.

The productivity of assets also depends on their acquisition date. Newer

assets operate with higher efficiency, although they are purchased at

higher prices. The use of gross (before depreciation) rather than net fixed

assets would eliminate this limitation. However, due to inflation, more

recently acquired assets would be more expensive and thus distort the

comparison of firms with older assets versus those with newer assets.

ii. Total asset turnover

The total asset turnover is an overall activity measure, which is used

as an indicator of the efficiency with which a company is deploying its

assets to generate sales. This relationship provides a measure of overall

investment efficiency by aggregating the joint impact of both short and

long-term assets.

Total assets turnover=Sales/(Average total assets)

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Liquidity Analysis

Liquidity analysis is used to assess the risk level and ability of a firm to

meet its current obligations. Satisfying these commitments requires the

use of cash resources available as at the balance sheet date and the

cash to be generated through the operating cycle of the firm.

The firm purchases or manufactures inventory, which requires an outlay of

cash and/or trade payables. The sale of inventory results in receivables,

which when collected, are used to pay off the trade payables, and the

cycle repeats. The ability to repeat this cycle on a continuous basis

depends on the firm’s short-term cash generating ability and liquidity.

Length of Cash Cycle

One indicator of short-term liquidity uses the activity ratios as a liquidity

measure. The inverse of the inventory and accounts receivable (A/R)

turnover ratios indicates the number of days it takes until inventory is

liquidated and receivables (generated by those sales) are converted

to cash, respectively. Therefore, for a trading company, the sum of the

two ratios indicates the length of the firm’s operating cycle, that is, the

number of days it takes for inventory to be converted to cash.

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Cash conversion cycle

Cash operating cycle=Accounts receivable days+Inventory days

Cash flow cycle=Cash operating cycle-Days payable outstanding

Days payable oustanding=365/(Accounts payable turnover)

Accounts payable turnover= (Total supplier purchases)/(Average

accounts payable)

The firm’s cash operating cycle is reduced when days payable

outstanding are considered. The inverse of the accounts payable

turnover ratio is equal to reflecting the number of days it takes until

the payables are settled. Subtracting accounts payable outstanding

from the time interval it takes to convert inventory to cash represents the

firm’s cash flow cycle, that is, the number of days a company’s cash is

tied up by its current cash flow cycle.

Working Capital Ratios and Defensive Intervals

The concept of working capital relies on the classification of assets and

liabilities into “current” and “non-current” categories. The traditional

definition of current assets and liabilities is based on a maturity of less

than one year.

270

In the typical balance sheet, we find the following categories of current

assets:

a. Cash and cash equivalents;

b. Marketable securities;

c. Accounts receivable;

d. Inventories;

e. Prepaid expenses;

In addition, the following three categories of current liabilities:

a. Short-term debt;

b. Accounts payable; and

c. Accrued liabilities.

By definition, each current asset and liability has a maturity (the

expected date of conversion to cash for an asset; the expected

date of liquidation of cash for a liability) of less than one year. The

ratios used in short-term liquidity analysis evaluate the adequacy of

the firm’s cash resources relative to its cash obligations. Its cash

resources can be measured by the firm’s current cash balance and

potential sources of cash or its (net) cash flows from operations,

whereas the firm’s cash obligations can be measured by either its

current obligations or the cash outflows arising from operations.

The first three ratios to be described compare different measures

of the present level of cash resources with the present level of

obligations. The current ratio uses all current assets, which comprises

of inventory, accounts receivables and cash.

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Current ratio=(Current assets)/(Current liabilities)

Quick ratio= (Cash+Marketable securities+Accounts receivable)/

(Current liabilities)

Cash ratio=(Cash+Marketable securities)/(Current liabilities)

Quick ratio is similar to the current ratio, except that excludes inventory

from cash resources, recognising that the conversion of inventory to

cash is less certain both in terms of timing and amount. The other assets,

cash and marketable securities, are “quick assets” because they can

be more quickly converted to cash.

Cash ratio is the most conservative of these measures of liquidity as it

includes only actual cash and cash equivalent balances.

The use of the current (or quick) ratio implicitly assumes that the current

assets will eventually be converted to cash. However, it is not anticipated

that firms will liquidate their current assets to settle their current liabilities.

In order to maintain operations, certain levels of inventories and

receivables, as well as payables and accruals (which finance inventories

and receivables) are required. These ratios therefore measure the

“margin of safety” provided by the cash resources in relation to

obligations.

272

Liquidity analysis and activity analysis are both used interchangeably.

Poor receivables or inventory turnover restricts the usefulness of the

current and quick ratios, as the reported amounts of these ratios may

not truly reflect the liquidity of the firm. Current assets such as obsolete

inventory or uncollectible receivables may not be easily converted

to cash. Hence, short-term liquidity ratios should be examined in

conjunction with turnover ratios.

The cash flow from operations ratio addresses the issues of actual

convertibility to cash, turnover, and the need for minimum levels of

working capital (cash) to maintain operations by measuring liquidity

through a comparison of actual cash flows (instead of current and

potential cash resources) with current liabilities.

An important limitation of the preceding analysis of liquidity ratios is the

lack of an economic or “real-world” interpretation of those measures.

The defensive interval is one tool that provides an intuitive “feel” for a

firm’s liquidity, although it is the most conservative one. It compares the

currently available liquid sources of cash (cash, marketable securities

and accounts receivable)

Cash flow from operations ratio=(Cash flow from operations)/

(Current liabilities)

Defensive interval=(Cash+Marketable securities+Accounts

receivable)/(Projected expenditures)

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with the estimated expenditure required to operate the firm. There are

different forms of the defensive interval as well as various methods to

arrive at the projected expenditures. Only the basic form has been

presented here. with the estimated expenditure required to operate the

firm. There are different forms of the defensive interval as well as various

methods to arrive at the projected expenditures. Only the basic form

has been presented here.

Long -Term Debt and Solvency Analysis

The analysis of a firm’s capital structure is essential to evaluate its long-

term risk and return prospects. Leveraged firms provide excess returns

to their shareholders as long as the rate of return on the investments is

greater than the cost of debt, used to finance the investments. However,

financial leverage has additional risks in the form of fixed costs that

adversely affect profitability if demand declines. Moreover, when

adversity strikes, the priority of interest and debt claims can have a

severe negative impact on a firm. Failure to meet these obligations can

lead to default and possibly bankruptcy.

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Debt Covenants

Long-term creditors often impose restrictions (debt covenants) on

the borrowing company’s ability to incur additional debt as well as on

dividend payments, in order to protect their claim. Debt covenants are

often expressed in terms of maintaining a specific working capital,

profitability and net worth. It is, therefore, important to monitor the

various ratios to ensure that their levels are in compliance with the debt

covenant requirements. Violations of debt covenants frequently trigger

an “event of default” under loan agreements, making the debt due

immediately. Hence, borrowers must either repay the debt (not usually

possible) or obtain waivers from lenders, when debt covenants are

violated. Such waivers often impose additional collateral, restrictions on

firm operations, or higher interest rates.

Capitalization / Debt Ratios

A firm’s financing is obtained from either equity or debt, or a combination

of both. The capitalisation or debt ratios examine the capital structure

of the firm and thereby indirectly the ability to meet current or additional

debt obligations. Debt ratios are expressed as either debt to total capital

or debt to equity.

Debt to total capital=(Total debt (current and long term))/(Total

capital (debt and equity))

Debt to equity= (Total debt)/(Total equity)

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The definition of short-term debt may or may not include operating

(trade) debt (accounts payable and accrued liabilities). The argument

for excluding it is that operating debt is part of the normal operations of a

firm and as such, it does not reflect a firm’s external financing decisions,

as opposed to short-term debt financing. However, it should be noted

that many lenders use a definition of debt that includes all liabilities.

Debt ratios measures the riskiness of a firm. A higher debt ratio indicates

that the firm is risky. However, industry factors play an important role in

determining an industry wide acceptable level of debt as well as the

nature of the debt - whether short or long term, variable or fixed, and

the relative proportion of different maturities. Capital-intensive industries

tend to have high levels of debt required to finance property, plant and

equipment. Moreover, the term of the debt should match the horizon of

the assets acquired.

Defining debt or equity is not always a straightforward task. The existence

of leases (whether capitalised or operating), other off-balance sheet

transactions such as contractual obligations not accorded accounting

recognition, deferred taxes, financial instruments with debt and equity

characteristics, and various forms of innovative financing techniques

must all be taken into consideration when computing and analysing the

ratios.

276

Interest Coverage Ratios

A more direct measure of the ability to meet interest payments is the

interest coverage ratio, which indicates the degree of protection available

to creditors, by measuring the extent to which earnings available cover

the interest payments.

A more comprehensive measure, the fixed charge coverage ratio,

includes all fixed charges arising from a firm’s debt commitments. Fixed

charges are defined as contractually committed periodic interest and

principal payments on leases as well as funded debt.

Variations of the two ratios above use adjusted operating cash flows.

Times interest earned=(Earnings before interest and taxes (EBIT))/

(Interest expense)

Fixed charge coverage=(Earnings before fixed charges and taxes)/

(Fixed charges)

Fixed charge coverage ratio (cash basis)=(Adjusted operating cash

flow)/(Interest expense)

277

Capital Expenditure and Cash Flow from Operations to Debt Ratios

In addition to servicing debt, internally generated cash flows are also

required for the purpose of investment. The interest coverage ratio(s) fail

to consider this aspect. Cash flow from operations is calculated without

any deduction for the cost of operating capacity. Net income, with its

provision for depreciation, reflects the use of assets. However, even with

minimal inflation rates, over their relatively long service life, replacement

costs of these assets tend to be significantly higher, and historical cost

depreciation cannot adequately account for their replacement. Neither

net income nor cash from operations, of course, makes any provision for

the capital required for growth.

A firm’s long-term solvency is a function of its ability to finance the

replacement and expansion of its investment in productive capacity

and the amount of cash left for debt repayment after paying for capital

investments.

Capital expenditure ratio=(Cash from operations)/(Capital

expenditures)

The capital expenditure ratio measures the relationship between the

firm’s cash generating ability and its investment expenditures. If the

ratio exceeds one, it indicates the amount of money the firm has left for

debt after payment for capital expenditures.

278

A more direct measure of the ability to meet interest payments is the

interest coverage ratio, which indicates the degree of protection available

to creditors, by measuring the extent to which earnings available cover

the interest payments.

Profitability Analysis

A firm’s profitability can be measured in various differing but interrelated

dimensions. First, there is the relationship of a firm’s profits to sales, that

is, what is the residual return to the firm per sales? The second type

of measure, return on investment (ROI), quantified as return on total

assets (ROA) or return on equity (ROE), relates profits to the investment

required to generate them.

Return on Sales

One measure of a firm’s profitability is the relationship between the firm’s

costs and its sales. The greater a firm’s ability to control costs in relation

to its revenues, the more its earnings power is enhanced. A common

size income statement can provide detailed information as to the ratio

of each of the component cost items to sales. In addition, five summary

ratios listed next measure the relationship between different measures

of profitability and sales.

CFO to debt=CFO/(Total debt)

279

i. Gross margin: It represents the percent of total sales revenue that

the company retains after incurring direct costs associated with

producing the goods and services it sells.

ii. Operating margin: It provides information about a firm’s profitability

from the operations of its “core” business without regard to:

a. Investment policy (e.g. income from affiliates or gains/losses

arising from sale of assets)

b. Financing policy (interest expense)

c. Tax position (if applicable)

iii. Profit margin: It is a measure that is independent of both the

firm’s financing and tax position.

iv. Pre-tax margin: It is calculated after financing costs (interest)

but prior to income taxes:

Gross margin=(Gross profit)/Sales

Operating margin=(Operating income)/Sales

Margin before interest and tax=(Earnings before interest and tax)/

Sales

Pre-tax margin=(Earnings before tax (EBT))/Sales

280

v. Profit margin: It is the overall profit margin of the firm, which excludes

all the expenses.

Profit margin=(Net income)/Sales

Return on assets=(Net income+After tax interest cost)/(Average total

assets)

Return on assets=(Earnings before interest and taxes)/(Average total

assets)

Return on Investment

ROI measures are computed with return measured either by excluding

financing expenses or by excluding both financing and tax expenses.

Return on assets (ROA), measures the operating efficiency of the firm

without regard to its financial structure. The return is defined as net

income prior to the cost of financing and is computed by adding back

the (after-tax) interest cost;

A variation of the ROA ratio uses pre-tax earnings as the return measure,

thereby bypassing not only the firm’s financing policy but its tax position

as well:

281

It should be noted that the ROA measure is sometimes computed

“after interest” as either net income or earning before tax over assets.

Pre-interest measures of profitability facilitate the comparison of firms

with different degrees of leverage. Using post interest measures of

profit negates this advantage and makes leveraged firms appear

less profitable by charging earnings for payments (interest) to some

capital providers (lenders) but not others (stockholders). Ratios that

use total assets in the denominator should include total earnings

(before interest) in the numerator. As interest is tax deductible,

interest payments must be tax effected when a post-tax measure of

profits is used.

The second commonly used ROI measure focuses on the returns

accruing to the residual owners of the firm i.e. common shareholders.

A more general definition of this relationship computes the return on

total stockholders’ equity.

The relationship between ROA and ROE can be understood in

terms of the firm’s relationship to its creditors and shareholders. The

creditors and shareholders provide the capital needed by the firm to

acquire the assets needed for the business. In return, they expect to

be rewarded with their share in the firm’s profits.

Return on common equity (ROCE)=(Net income-Preferred

dividends)/(Average common equity)

Return on equity=(Net income)/(Average total equity)

282

The ROA measure can be interpreted in two different ways. First, it is an

indicator of management’s operating efficiency i.e. how well management

is using the assets at its disposal to generate profits. Alternatively, it

can be viewed as the total return accruing to the providers of capital,

independent of the source of capital.

The ROCE measures reflect returns to the firm’s common shareholders

and is calculated after deducting the returns paid to the creditors

(interest) and other providers of equity capital (preferred shareholders).

Ratios: An Integrated Analysis

The ratios analysed are used to measure an enterprise’s liquidity,

solvency, profitability, and efficiency of operations (activity ratios). The

earlier discussion of ratios has focused on their individual characteristics.

Comprehensive analysis requires a review of the interrelationships

among ratios, resulting from the following factors:

i. Economic relationships: The underlying economics of a firm result

in elements of the financial statements moving together. For example,

higher sales are generally associated with higher investment in

working capital components such as receivables and inventory.

Ratios comprising these various elements would be correlated.

ii. Overlap of components: A cursory examination of the ratios

examined indicates that the components of many ratios overlap. This

overlap may result from ratios having identical terms in the numerator

or denominator or because a term in one ratio is a subset of a

component of another ratio.

283

In a similar vein, the total assets turnover ratio is essentially a (weighted)

aggregation of the individual turnover ratios. Ratios that aggregate

other ratios can be expected to follow patterns over time similar to

those of their components.

iii. Ratios as composites of other ratios: Some ratios are related to

other ratios across categories. For example, the return on assets

ratio is a combination of a profitability and turnover ratio.

The inter-relationships among ratios have important implications for

financial analysis. On the one hand, disaggregation of a ratio into its

component elements provides insight into factors affecting a firm’s

performance. Further, ratio difference can highlight the economic

characteristics and strategies of:

a. Firms in the same industry

b. The same firm over time

c. Firms in different industries

On the other hand, the relationships between ratios imply that one might

be able to “ignore” some component ratios and use a composite or

representative ratio to capture the information contained in other ratios.

For example, in the ROA relationship earlier, the effect of the two ratios

on the right side of the equation may be captured by the ROA ratio.

Analytic purposes, this composite return on assets ratio may suffice.

Return on assets=Sale/Assets×(Net Income)/Sales

284

Analysis of Firm Performance

This section will discover some of the inter-relationships to analyse

a firm’s performance by focusing on disaggregation of the overall

profitability measures, which include ROA and ROE.

Disaggregation of ROA

The return on assets ratio can be disaggregated as follows:

This disaggregation of ROA indicates that the firm’s overall profitability

is the product of an activity ratio and a profitability ratio. A low ROA,

for example, can reflect either low turnover, indicating poor asset

management or low profit margin even when turnover is high. A

combination of both is also possible.

The disaggregation can lead to analysis of a firm’s performance (over

time or with respect to that of other firms) in a hierarchical fashion.

Changes or differences in ROA can be traced first to changes in activity

and/or profitability. Note that profitability is measured by earnings before

interest and taxes (EBIT). The use of EBIT rather than net income has

the advantage of showing trends independent of the capital structure

of the firm. This analysis can be refined further by examining individual

turnover ratios and the elements of profitability.

Return on assets=Sale/Assets×(Net Income)/Sales

Return on assets=Total asset turnover ×Return on sales

285

Disaggregation of ROE and its Relationship to ROA

The next logical step involves a detailed examination of the return

on equity. From the perspective of equity analysis, net income is the

measure of profitability, as only the residual (after interest expense,

income taxes etc.) belongs to the common stockholder.

Disaggregation of ROA into Basic Components

The relationship of ROE and ROA is a function of the proportion of debt

used for financing and the relationship of the cost of debt to the ROA.

This can be formally expressed as:

In effect, the benefits of financial leverage are a product of the excess

returns earned on the firm’s assets over the cost of debt and the

proportion of debt financing to equity financing. If there are no excess

returns (i.e. ROA < cost of debt), then ROE will be less than ROA.

The relationship between ROA and ROE may also be expressed as

Return on equity=ROA+(ROA-Cost of debt)× Debt/Equity

Return on equity=Return on assets- (Interest cost)/Assets×Assets/

Equity

286

The assets/equity ratio is a capital structure/financial leverage ratio

indicating the degree to which assets are internally financed. The larger

the ratio the more outside financing. It is equal to one plus the debt/

equity ratio where debt is defined as total liabilities. Thus, when we

recall the categories making up the ROA ratio, the ROE relationship can

be shown to be a function of three of the four categories discussed as

shown below.

The analysis of the components of ROE, which is frequently known as

the «DuPont model», enables the Valuer to discern the contribution of

different factors to the change in ROE.

While the three-component model shown is the standard DuPont model,

it can be developed further. In many cases, it is worthwhile to look at

the effect of interest payments or tax payments. To do so we must

disaggregate the profitability ratio further as shown bel

Return on equity=Profitability ratio ×Activity ratio ×Solvency ratio

Return on equity= Income/Sales×Sales/Assets×Assets/Equity

Profitability ratio= (Net income)/EBT×EBT/EBIT×EBIT/Sales

287

Appendix K :Valuation Report - Table of Contents Template

6.11

Valuation summary

1. Engagement background (identity of client, information

about subject entity)

2. Sources of Information (information by management,

private, public data bases)

3. Valuation Results (brief overview of valuation analysis,

results, etc.)

4. Matters of Emphasis (major factors/assumptions

provided by management)

Statement of Limiting Conditions

5. Statement of Limiting Conditions (representation by

Valuer, extent of liabilities, etc.)

Background

6.Transaction overview (if valuation is required for

actual or proposed deal)

7. Business background (details about operations of

subject entity)

8. Financial information (historical financial statements,

etc.)

07

08

09

10

11

12

13

15

16

17

18

288

Valuation analysis

9. Summary of values (values achieved by various

methods, etc.)

10. Assumptions (used by the Valuer for arriving to

conclusion, fill information gaps)

11. Projected Financials (provided by management or

built by the Valuer, if required)

12. Valuation analysis (workings of Valuation method/s

performed)

11. Discount Rate

Annexure A: Valuation workings

19

20

22

26

29

30

34

289

Appendix L :Sample short form report6.12

[Date]

[Name of Client and title]

[Address of Client]

Dear [name]:

Valuation of ABC Company

Introduction

In accordance with the Letter of Engagement between ABC (“client”,

“you”, “Company” or “ABC”) and XYZ (“we”, “us” or “XYZ”), we have

performed a valuation analysis of the market value as at 31 December

2016 of ABC Company.

290

Appendix M :Completion Letter template6.13

[Date]

[Name of Client and title]

[Address of Client]

Dear [name]:

We have completed our engagement [or phase of engagement] to

[describe the objective of our overall integrated or single competency

engagement] under the Agreement, dated ________, between [legal

name of XYZ firm party to the Agreement] (“we” or “XYZ”) and [Client

party to the Agreement /SOW] and the Statement[s] of Work dated [insert

dates] (together, the “Agreement”). If we use a capitalized term in this

letter, but do not define it, it has the meaning set out in the Agreement.

[Add further background here, as needed, to provide brief context of

understanding of client’s objectives and needs]

Scope of our work to date [amend wording as required]

[This section summarizes the scope of the work performed and any

exclusions and/or significant limitations. Related activities not covered

in the scope are described here if necessary to delineate the boundaries

of the engagement. The nature and extent of procedures performed

also are described here. Be very careful NOT to contradict the scope

of services set out in the Agreement, as it may have been amended –

check the original scope]

291

As set out in the Agreement, during the period [insert beginning and

completion dates], we performed Services that included [include a

brief description of the nature of the overall work performed and the

time period covered]. The scope of our work included [include here

summarized procedures performed approved by scope of work or

make reference to an attachment]. [Also, include here a description of

any significant limitations considered important to highlight].

Results of our work

During the course of performing these Services, we provided you with

written and other Reports including [insert name/title/date(s) of written

work product(s) and/or describe tools, templates, progress reports,

presentations, schedules, information, etc. tailored to the specific

engagement].

[Consider also including information about positive aspects of the

client’s business (for example, milestones met, processes/phases

completed, and improvements since the last engagement or phase) to

fairly represent the existing issues and provide perspective and balance

to the work product.

Our Services, and our advice, recommendations and other Reports,

were based on information provided by you or on your behalf. While we

believe that the Services were substantially responsive to your request

for assistance, we are not in a position to assess their sufficiency for

your purposes. We did not evaluate the reliability or completeness of the

information we received or of the explanations provided by management

or others. Please note that we are not required to update our work or

perform any services after the completion date set forth above.

292

Although the Agreement addresses these issues, we wish to remind you

that:

• You alone are responsible for any decision to implement any of our

advice or recommendations, as well as for the actual implementation

thereof and the results of implementation. We make no representation or

warranty that you will be able to implement our advice, recommendations

or strategies effectively or successfully, or with respect to your results.

• Only you (including your board) may use our Reports, and, except

as expressly permitted in the Agreement, you may not disclose them to

anyone else.

• We express no opinion or any other assurance on your historical or

prospective financial statements, management representations or any

other data included in or underlying the information we received. We

take no responsibility for any of your prospective financial information or

underlying assumptions, or your ability to achieve identified prospective

financial results.

293

Next Steps

[This section could be used to:

• Discuss and/or propose next steps relating to actual and potential

follow-on engagements.

• Request formal feedback or request the opportunity to schedule a

client meeting to obtain performance feedback in person].

We appreciate the cooperation and assistance you provided to us

during the course of our work. Thank you for the opportunity to assist

you with this engagement [Further customize as needed]. If you have

any questions, please call [Valuer] at [insert telephone number].

Very truly yours,

[XYZ Limited]

294

Appendix N :Engagement Completion checklist template

6.14

Client :

Engagement title :

A. To be signed by the engagement team

We confirm the following:

1. The client/ engagement acceptance and conflict of interest

procedures have been followed;

2. A detailed information checklist was shared with the client at the start

of the engagement and later on followed up. Information asked but not

provided by the client has been mentioned in the client deliverables;

3. We have sought appropriate industry insights and ideas;

4. All relevant telephone conversations and meetings (including

presentations) have been adequately documented and considered in

the valuation;

5. Any doubt / clarification required, during the course of the

engagement has been highlighted / discussed with the engagement

manager;

6. We have reviewed all client deliverables, including the valuation

workings;

7. All casts and cross references in the report have been checked;

8. We have received the latest audited accounts of the valuation

subject, read the annual report and highlighted the key information

affecting valuation to the Manager;

9. We have checked the multiples calculation for correctness;

295

10. We have compiled the control file and completed the checklist;

11. All the information sent by the client has been appropriately

considered for the valuation analysis and/or discussed with the

engagement manager;

12. We have prepared the deliverables to the best of our ability and with

due care; and

13. We have ensured that all the review comments of the Partner on

valuation workings and report have been incorporated.

Team member name Designation Signatures

296

Appendix O :Example of Valuation Release Letter6.15

Pro forma release letter to third party requesting sight of report prepared

for client (with additional wording for inclusion if we are required to meet

with the third party)].

Private and confidential

[Date]

[Addressee (Third Party)]

Dear Sir

Report on [Target]

We have been requested by [Client] to provide you with a copy of the

[draft] report dated [date] we prepared, on its instructions, on [Target]

(“the Report”) [and meet with you to answer questions relating to the

Report. Any comments made by us or information provided either at

any meeting or subsequently are referred to as the “Information”]. We

hereby provide a copy of the Report to you, conditioned upon each of

the Client and your prior signed agreement to the terms of this letter

agreement and our prior receipt of each of those signed agreements.

The Report was prepared solely for the purpose of [state purpose of

our report] and addressed issues specific to [Client]. The Report was

not prepared in anticipation of being provided to third parties, [similarly

neither our work nor our Report contemplated a meeting with you or any

other third party] and we did not have the interest of anyone other than

[Client] in our contemplation when we carried out our work. Accordingly,

we may not have addressed issues of relevance to you.

297

Our work in connection with the Report[s] was completed on [insert

date of completing work, as stated in transmittal letter], which may be

some time before the Report[s] [is/are] provided to [new addressee],

and has not been updated for subsequent events and transactions or

for any other matters which might have a material effect on the contents

of the Report[s] [Insert any other relevant caveats, e.g. only providing

part of report, restricted access when doing our work, no responsibility

accepted for the Vendor Due Diligence (“VDD”) report or any other third

party Due Diligence (“DD”) report used in our work.]

Whilst we are prepared to release a copy of the Report to you [and meet

with you], it is only on the basis that you acknowledge and agree that:

1. XYZ (Valuer), including its affiliates, partners, employees, agents,

and subcontractors accepts no responsibility and shall have no liability

in contract, tort or otherwise to you or any other third party in relation to

the contents of the Report [or the Information];

2. [Where applicable, include the exact ‘hold harmless’ wording

required by the auditors (whether XYZ or another firm) in connection

with the review of the audit or tax files.

[Auditors] have no responsibility or liability whatsoever to you in

connection with their audit or any information or explanations sought

by us in the course of our review of the audit working papers [or the tax

papers]. We draw your attention to the Notice included on page [ ] of

the Report];

3. Any use you make of the Report [or the Information] is entirely at

your own risk;

298

4. You will not provide copies of the Report [or details of the Information]

to any party (i) other than your professional advisers acting in that

capacity provided that they accept the terms and conditions relating to

restrictions on use and distribution of Report [or the Information], as set

out herein or (ii) unless required by court order or a regulatory authority,

without our prior written consent. Notwithstanding the above, you may

disclose to any and all persons, without limitation of any kind, including

any fact that may be relevant to understanding such valuation analysis,

and all materials of any kind provided to you in relation to such value

conclusion. However, because the valuation is solely for [Client›s]

benefit and is not to be relied upon any other person or entity, you shall

inform those to whom you disclose any such information that they may

not rely upon any of it for any purpose without our prior written consent;

5. Without prejudice to other rights and remedies that XYZ may have,

you shall, to the extent not prohibited by applicable law, promptly make

good and indemnify XYZ, including its affiliates, partners, employees

and representatives, upon express notice by XYZ, from any costs and

expenses (including without limitation, attorneys’ fees and time of XYZ

personnel), paid or incurred by XYZ at any time, in relation to any third

party claims, and which claims are finally determined in any way to have

arisen out of or relating to your access to the Report;

299

6. Where any other member of the global network of XYZ firms has

assisted us in the preparation of the Report or has provided Information

(each an “XYZ Firm”), they will be entitled to benefit from and enforce

the terms of this letter; and

7. This letter shall be governed by and construed in accordance with

the laws of Saudi Arabia and any dispute arising out of this letter shall

be subject to the exclusive jurisdiction of the courts at “jurisdiction”.

We should be grateful if you would sign a copy of this letter where

indicated and return it to us as soon as possible.

Yours faithfully

[ ]

Designation

XYZ

We acknowledge and agree to the terms set out in this letter.

................................... Date ………………………

for and on behalf of

[Third Party]

We acknowledge and agree to the terms set out in this letter.

.................................... Date ………………………

for and on behalf of

[Client]

300

2. Objective

The objective of our valuation was to provide recommendations to ABC

Company in connection with the proposed sale of its interests in its

factory to third parties. We understand that the Company will use our

recommendation solely for this purpose.

The valuation in the report are based only upon the information provided

to us by the company’s management. We did not carry out any

procedures to verify the accuracy of the information, nor do we assume

responsibility for its accuracy.

Summaries of, or references to, the report that are to be presented to

third parties must be reviewed by us, and that information may not be

released without our prior approval.

3. Definition of market value

For the purpose of this analysis, market value is defined as: “the price

at which an interest would change hands between a willing buyer and

willing seller, neither being under compulsion to buy or sell and both

having reasonable knowledge of all relevant facts as of the Valuation

Date”.

4. Statement of limiting conditions and assumptions made

Our valuation is contingent on the following limiting conditions and

assumptions made by us:

1. The Company will achieve its targets in terms of capacity utilization,

sale price per unit increases and net profit during the projection

period.

301

2. The recommended value contained is intended only to represent the

value of the Company as of the Valuation Date. Subsequent changes

in market conditions could result in a substantially different valuation

than what has been estimated.

3. Information provided to us by the Company, which forms a basis for

our recommended value, is believed to be reliable but has not been

verified independently unless otherwise stated.

4. The prospective financial information provided to us is based on

expectations of competitive and economic environments as they may

affect Company’s future operations. We understand that management

have applied consistently key assumptions during the projection

period and have not omitted any relevant factors.

5. The prospective financial information provided to us by management

has been prepared using assumptions that include hypothetical

assumptions about future events and management’s actions that may

not be achieved. Even if the events anticipated under the hypothetical

assumptions take place, the actual outcome is still likely to be different

from the projections included in the prospective financial information

since anticipated events frequently do not occur as expected and the

variation may be material.

6. The value is based on the assumption that the company’s capital as

at the Valuation Date will continue unless otherwise stated.

7. Our report assumes that the Company has an unrestricted title to all

the assets unless otherwise stated.

302

8. Our report assumes that the Company complies fully with local laws

and regulations, unless otherwise stated, and that it will be managed

in a competent and responsible manner.

9. This report should not be considered as investment advice. The

value shown is only indicative of the ultimate price that may be agreed

between a willing buyer and a willing seller after the required due

diligence procedures have been undertaken.

10. Information provided to us from the management Company

forms the basis upon of our valuation. Hence, omission of any material

information provided to us would have a significant impact on the

valuation

5. Business Valuation

The valuation has been carried out on the following principles:

• Value is as of the Valuation Date.

• Value is a function of what a business expects to earn in the future

as at the Valuation Date.

• Going concern values are assessed in relation to the value of

the net assets viewed as a whole which are expected to generate

earnings. Higher tangible asset backing supports higher going

concern value.

• Liquidity of a business has a direct impact on its price.

•

Based on the above, the Income and Asset approach is used to value

businesses that are not publicly traded.

303

6. Summary of valuation

11. Our valuation analysis estimates the market value of ABC as at 31

December 2016 for the proposed sale is based on the application of

the two methods of the Income Approach; namely DCF and Adjusted

Net Asset method.

12. Taking into consideration the fact that the Company has a large

fixed asset base, for comparative purposes, we have also shown the

adjusted net asset value of ABC at 31 December 2016. Adjusted Net

asset value may be applied where the DCF methods provide values

higher than the adjusted net asset value.

Based on our analysis the market value of ABC %100 equity interest as

at 31 December 2016 is in the range of SAR 118.7m and SAR 139.8m.

This report is subject to the statement of limitation conditions and

assumptions made in section 4 of this report.

Very truly yours,

ABC Limited

By: ________________________________________________

Authorized Signatory

SAR (m) Discounted cash flow Net Asset Value

Valuation

Redundant Assets

129.8

10

118.7

Indicative Value 139.8 118.7

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