Archive for June, 2018

Business valuation is a constant challenge for the business people and professionals alike. While many security analysts do not have the accounting background, they often engage in valuing companies.

Professionally managed firms, especially public companies, must adhere to the consistent financial accounting and reporting rules such as the GAAP mandated in the US by the Securities and Exchange Commission (SEC).

SEC discourages private discussions between the public company management and independent security analysts these days, so digging up additional information beyond the filed GAAP financials is not easy. Most significantly, the company’s financials disclosed to the public do not provide much guidance on the values of company’s intangible assets.

From the asset approach perspective, business intangible asset value is potentially a very significant contributor to the value of the business enterprise. So how can an analyst estimate the value of a business in the absence of information on the valuation of the patents and trademarks, internally developed technology, skilled workforce, distribution channels, and customer lists?

If you are skeptical about the ability of a valuation expert to come up with an accurate business valuation without such information, you are not alone.

Many seasoned analysts know this and defend their view of business value by claiming the understanding of the key value drivers for the target companies. In other words, an experienced analyst develops an insight into the underlying business assets that are not explicitly valued in the disclosed financial and operational statements.

Less experienced analysts could arguably be swamped by the flood of data on a company and fail to make sense of all the ‘moving parts’. They feel that the accounting statements they have access to are about all they can handle in order to estimate business value.

So there you have it. Analysts tend to develop their opinions based on both the information available as well as their ability to glean the additional details on what creates business value. The conclusion is only as good as the credibility of the business appraiser.

Fundamental to the business valuation process is the need to make assumptions about future events. What the business is worth today depends upon future cash flows. These future business earnings are a function of business future performance, financially and operationally.

Business value is about the future earnings and risk

No matter how you slice it, you need to take a leap of faith and make some critical assumptions about how things will turn out.

Do errors of judgement occur? Yes, indeed. How useful your business appraisal is depends in large part on how well you can foresee the future for the company.

Devil in details – business valuation depends on your assumptions

Both the business appraiser and business clients reading the valuation report must take ownership of the process here. As a business person, you should read the entire report, not just the business value conclusion section. Otherwise, you may miss important assumptions that qualify the valuation result. The body of the appraisal report should tell you how these assumptions have led to the business value number at the end. Equally importantly, you can spot how sensitive the valuation result is to the key value drivers your business appraiser has considered.

In business valuation, the assumptions drive the results. If the assumptions are seen as reasonable by the intended readers of the report, the conclusion should come as no surprise.

If, on the other hand, you find the business valuation conclusion troubling, go back to the assumptions made at the outset. If still in doubt, ask your appraiser to clarify the assumptions or run what-if scenarios under alternative expectations to assess their effect on business value.