"The cynic knows the price of everything but the value of nothing" Oscar Wilde
"Price is what you pay for. Value is what you get" Warren Buffet
It is quite common for people to confuse the price of an asset for its value. As famously put forth above by Warren and Oscar, the value of an asset is certainly a tricky metric to navigate. And it is perhaps with this in mind that in the area of business valuation, standards have now been developed and adopted in the business community to make less random the assessment of a business's value.
Nevertheless, unlike price, valuation is still as much an art as the art pieces that is subject to valuation in art galleries and auction. It is often said, and true, that no two valuer will arrive at the same valuation. But with the establishment of valuation standards, the days of when an asset's value is a number plucked from the sky are numbered.
So what does a business valuation typically entails?
Establishing a basis of value
While this is usually decided by us, the valuer, we feel it is important to explain what the common bases of value are:
Market value (usually for M&A or divestment)
Fair value (usually for financial reporting)
Market value is defined as 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 knowledgeable, prudently and without compulsion. Investment Value is the value of an asset to a particular owner or prospective owner for individual investment or operational objectives. Fair Value is defined 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.
2 Determining the Valuation Method(s) From the basis of value, we would then determine which valuation approach would be suitable to arrive at the basis of value. There are :
Income Approach, and
Cost (Asset) Approach
The market approach provides an indication of value by comparing the asset with identical or comparable (that is similar) assets for which price information is available. This approach is particularly suitable in cases where the financial performance of the business or company being valued can be compared to its industry peers, e.g. in scenarios where the business or company is listed in an active market.
The income approach provides an indication of value by converting future cash flow to a single current value. Under the income approach, the value of an asset is determined by reference to the value of income, cash flow or cost savings generated by the asset. Needless to say, cash flow projections is an absolute necessity when using this method.
The cost approach provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction, unless undue time, inconvenience, risk or other factors are involved. The approach provides an indication of value by calculating the current replacement or reproduction cost of an asset and making deductions for physical deterioration and all other relevant forms of obsolescence.
Depending on the circumstance, a valuer may adopt more than one approach to arrive at the valuation.
3 Information gathering and vetting Having established the basis and method of valuation, we will usually request for the following information:
Market share and key domestic and regional competitors
Historical financial data
Prospective financial information
We will usually conduct a review of the information provided, especially on the prospective data to ensure the underlying assumptions are reasonable. Of course, this does not constitute as an audit.
We hope the above sheds some light into what a professional valuation engagement entails. If you require a business or company to be valued, contact us today!