Business Valuation is the process and the set of procedures of determining how much a business is worth Business Valuation tools, 2012.The business worth only as much as its ability to make profits. Knowing the value of a business is critical to maximizing the investments, whether buying or selling a business. Moreover, the value of a business and understanding how to calculate business value is very important when planning the `exit strategyÂ´. (Business Valuation, 2010).
Problems of valuing a Company:
Company valuation is not an exact science. There are numerous and acceptable valuation approaches and although all methods should yield the same result, they rarely do, because of different factors (Market conditions, the industry in which the target company operates and the nature of the business) (Sherman, A.J et.al, n.d.)
Business Value means different for different people
Economic conditions affect to the meaning
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The real price may vary quite depending on who determines the business value.
Results may be different using different methods.
Process of Valuation:
The process of determining the value of a business has different steps. According to recent research in Business Valuation Strategies, the step that a valuator has to follow are:
Define the value of the business: It is important to define the value the business is seeking, which depends on the valuationÂ´s purpose.
Gather data: The valuator gathers economical information, financial statements of the company, the value of the assets, tax returns and possible other offers the company had in the last few years.
Determine the value: Decide which valuation approach is going to be used according to which one gives the most accurate value for the company.
Adjust the value: Consider factors that affect the value, as for example the marketability, voting rights and specific circumstances relating to the company.
Briefly summary of Valuation Approaches:
There are many methods of Business Valuation. The most common approaches are: The Income approach, the Market Approach and the Asset Approach.
The Income Approach basing in the Business Dictionary is a method of calculating the appraisal value of a company according to its opportunity cost. It is also called ``income capitalization approachÂ´Â´.
Market Value=Â Net Operating Income
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The Market Approach calculates the value of a company on the basis of the prices of similar items that are being sold in the market within the last three to six months, adjusting for differences in quality, quantity or size. (Business Dictionary, n.d.).
Finally, in the Asset Approach (also known as Cost Approach) assets, both tangible and intangible, and liabilities are valued separately at fair market value. This method is used in most of the Non-Profit Organizations (Abraham, G.D., 2012).
A deeply analysis of each approach is developed below.
The asset approach, also called cost approach or balance sheet approach consists to valuate a business by subtracting the value of its liabilities from the value of its assets (Allied, n.d.). The values used in those calculations are the fair market values which is define by the U.S. Treasury regulations as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts" (R. Hitchner, J. 2011, p.3).
The use of this approach is relevant for valuating companies that have tangible assets as primary source of value. Example of that are; shut down companies, firms that not operating properly or only to a portion of their capacity, and business that are not earning profits or are generating negative free cash flows (Gaberhart, S. & J. Brinkley, R., 2002). However, this approach relies on the capacity to determine the fair market values of all the assets and liabilities, even the ones that are not listed in the balance sheet (Gaberhart, S & J. Brinkley, R., 2002). Thus, for typical companies, poor results are generated from this approach (Gaberhart, S. & J. Brinkley, R., 2002).
The procedure to valuate a company with the asset approach has several steps. First, the balance sheet at the valuation date (or to the closest date) should be obtained in order to use it as a starting point to create a fair market balance sheet. Second, assets and liabilities which are not at the fair market value must be determined (R. Hitchner, J. 2011). Third, intangible and off-balance sheet assets need to be identify and evaluated. Fourth, assets market value must be subtracted from liabilities market value.
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As said previously, the asset approach should not be used to valuate typical companies as Porsche AG Group. Moreover, the required calculation to adjust the assets and liabilities often required services of professional appraisers, so, in this work, the asset approach company valuation for Porsche AG Group will be restricted to indicate if adjustments are required on the assets and liabilities present on its balance sheet of 2011 (which is the most recent balance sheet, so the closest date to the valuation date). The following table shows if adjustments are needed to the elements found in the Porsche AG Group 2011 balance sheet (Appendix ---):
First, many assets value need to be adjusted to the fair market value. Specifically, property, plant and equipment and leased assets (1) often have to been adjusted, and it, by a qualified appraiser (Allied, n.d). Financial assets (2) reflect the value of the company if they can be sold in the market place but they often need to be adjusted (R. Hitchner, J. 2011). Moreover, receivables (3) will probably not be all recovered, so an adjustment is required in order to eliminate the doubtful accounts of the fair market value (Allied, n.d). Since tax assets (4) refer to a cash amount (InvestorWords.com, n.d.); income tax assets do not need to be adjusted. Furthermore, inventories (5) shown in the balance sheet are not at their fair market value because the accounting convention for inventories requires to write it at the lower cost or market (R. Hitchner, J. 2011). Also, an adjustment is required for securities (6) because they need to be marked at the valuation date (R. Hitchner, J. 2011). Cash and cash equivalent (7) are liquid assets, which can be used by the company, so they are already valuated at the fair market value (Allied, n.d).
Second, some liabilities also need to be adjusted. However, adjustments to the results of a past contractual commitment or tax legislation (9) are not required if their amounts do not have been understated or overstated (R. Hitchner, J. 2011). Adjustment may be required to define the share market value of financial liabilities (10) because the interest rate may fluctuate over the time. Finally, trades payable (11) should not be adjusted since they are short-term obligations (R. Hitchner, J. 2011).
The third step of the asset approach for a company valuation is to determine and evaluate intangible and off-balance sheet assets and liabilities. However, this is also a complex step that will not be done in this work. Furthermore, it is also impossible to realise the fourth step which consist to subtract the market value of liabilities to the market values of assets since they did not have been calculated.
In brief, as the table shows, use the asset approach to valuate a company can lead to a value that grandly differ from the other approaches' one, since adjustment to the assets and liabilities shown in the balance sheet are required to put them at their fair market value.