HOW FINANCIAL STATEMENTS ARE USED IN VALUATION

Valuation What Does Valuation Mean?

The process of determining the current worth of an asset or company. There are many techniques that can be used to determine value, some are subjective and others are objective. 

For example, an analyst valuing a company may look at the company's management, the composition of its capital structure, prospect of future earnings, and market value of assets.

Judging the contributions of a company's management would be more of a subjective valuation technique, while calculating intrinsic value based on future earnings would be an objective technique.

Two Categories of Valuation Models

Valuation methods typically fall into two main categories:

1 . Absolute valuation models

Absolute valuation models attempt to find the intrinsic or "true" value of an investment based. Looking at fundamentals simply mean you would only focus on such things as dividends, cash flow and growth rate for a single company, and not worry about any other companies.

2. Relative valuation models.

Valuation models that fall into this category include the dividend discount model, discounted cash flow model, residual income models and asset-based models.

In contrast to absolute valuation models, relative valuation models operate by comparing the company in question to other similar companies.

These methods generally involve calculating multiples or ratios, such as the price-to-earnings multiple, and comparing them to the multiples of other comparable firms. For instance, if the P/E of the firm you are trying to value is lower than the P/E multiple of a comparable firm, that company may be said to be relatively undervalued. Generally, this type of valuation is a lot easier and quicker to do than the absolute valuation methods, which is why many investors and analysts start their analysis with this method.

Asset Based Valuation

What Does Asset Valuation Mean?

The process of determining the current worth of a portfolio company investment, or balance sheet item.

The tools used for asset valuation include quantitative methods & statistics, financial statement analysis, ratio analysis, fundamental analysis, etc.

Conducting An Asset Based Valuation The first thing you must do is make a

complete list of the tangible assets owned by your business. Examples of tangible assets include: accounts receivable, furniture and fixtures, equipment, inventory, customer contracts, vehicles, leasehold improvements, prepaid expenses (paid insurance premiums for example), franchise agreements.

Conducting An Asset Based Valuation Separate the asset which are marked to the

market (mostly current asset) If you own the real estate that your

business occupies you may be better off selling it separately from the business, which means it won't be part of this valuation.

But if the business is dependent on the current location, than add the value of the real estate in this step.

Conducting An Asset Based Valuation Next assign a price to each tangible asset based

on it's fair market value. Fair market value is what the item can be sold for on the open market. It may take some research to determine this.

Unless prices have changed drastically, inventory should be valued at your cost.

Sometimes an owner will attempt to value the company's assets based on book value ( the non-depreciated value of the item as it is currently valued on your balance sheet). It is the rare buyer who will pay you book value - they can buy brand new equipment and vehicles for nearly the same price as the book value.

Conducting An Asset Based Valuation assign a value to each item based on what it can

realistically be sold for on the open market. And make sure to note next to the price why it is worth that amount.

Finally, make a comprehensive list of the intangible assets owned by the company. Examples of intangible assets: Customer lists, proprietary information and software, trained and experienced employees and patents, copyrights trademarks, knowledge Assets, etc. Come up with what you consider to be a fair value for each item. Next, clearly describe the item and explain why you believe it is worth the amount you're asking.

Conducting An Asset Based Valuation An intangible asset that gets a lot of

attention is "goodwill". But Goodwill, in reality, is just the sum total of all of your intangible assets.

Adding the total of your tangible assets plus the total for your intangible assets will give you a good idea of what your asking price will be.

Valuation of Intangible Assets

Goodwill Knowledge Asset Brand Name Assets Synergy Asset “Combination Create Value” Hume Inventory Assets (Trained and experienced employees) Management Style and Cooperate Governance Enterprise Skills Customer lists (Customer relations) Chain of supplies Proprietary information and software and Patents, Copyrights, Trademarks

Applicability of Asset Based Valuation Approach

Asset based valuation technique are more feasible in following sector, where major part of assets are marked to the market and traded fairly in the market. So their tradable price and market price are easily available.

Investment Funds Financial Companies Asset Based Companies (Firms Dealing in Natural

Resources like oil field, Minerals Deposits, Timberlands)

Firms Trading at Market Value Less Than Net Assets

Firms trading at less than the value of the net assets on their balance sheets warrant particular attention.

Net assets are the book value of the operating assets minus operating liabilities, an amount that is also equal to the book value of the equity plus net debt.

The market value of these assets is the market value of the equity plus net debt. The ratio of the market value of net assets to their book value is the unlevered price-to-book ratio or the enterprise price-to-book ratio. See Box 3.2. The situation has one of two interpretations.

Firms Trading at Market Value Less Than Net Assets

The market is undervaluing the nets assets; so, in buying these firms, one expects to earn abnormal returns.

The carrying value of the net assets is too high; so one expects the firm to write down the assets in the future.

Break up value is greater than balance sheet value.

contemporaneous price arbitrage intertemporal arbitrage negative stub values. This situation

occurs when the market value of a parent company’s share in a subsidiary is worth more than the market value of the parent.