ACCOUNTING STANDARD (AS) 20

CHAPTER 1
EARNING PER SHARE
1. INTRODUCTION
This Accounting Standard is mandatory for all companies. However, disclosure of
diluted earnings per share(both including and excluding extra-ordinary item is not
mandatory for Small and Medium Sized Companies, as defined in the Notification.
Such companies are however encouraged to make these disclosures.
Earnings per share (EPS) is a company's net income (typically over the trailing 12
months) divided by its number of shares outstanding. EPS comes in two varieties, basic
and diluted. Basic EPS includes only actual outstanding shares of a company's stock,
while diluted EPS represents all potential stock that could be outstanding with current
stock option grants and the like. Diluted EPS is the more "conservative" number.
The Earning Per Share can be calculated as:EPS = (Total Company Earnings) / (Shares Outstanding)

1.1 DEFINITIONS
For the purpose of this standard, the following terms are used with the meanings
specified:

An equity is a share other than a preference share.

A preference share is a share carrying preferential rights to dividends and

repayment of capital.

A financial instrument is any contract that gives rise to both a financial asset of one
enterprise and a financial liability or equity of another enterprise.

A potential equity share is a financial instrument or other contract that entitles, or

may entitle, its holder to equity shares.

Share warrants or options are financial instruments that give the holder the right to
acquire equity shares.

Fair value is the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arms length transaction.

Equity shares participate in the net profit for the period only after preference
shares. An enterprise may have more than one class of equity shares. Equity shares
of the same class have the same rights to receive dividends.
A financial liability is any liability that is a contractual obligation to deliver cash or
another financial asset to another enterprise or to exchange financial instruments
with another enterprise under conditions that are potentially unfavourable.

1.2 OBJECTIVES
The objective of standard is to prescribe principles for the determination and
presentation of earnings per share which will improve comparison of performance
among different enterprises for the same period and among different accounting periods
for the same enterprises. The focus of this standard is on the denominator of the
earnings per share calculation. Even though earnings per share data has limitations
because of different accounting policies used for determining earnings, a consistently
determined denominator enhances the quality of financial reporting.

1.3 SCOPE
This Standard should be applied by all companies. However, a Small and Medium
Sized Company, as defined in the Notification, may not disclose diluted earnings per
share(both including and excluding extraordinary items).
In consolidated financial statements, the information required by this Statement
should be presented on the basis of consolidated accounting Standard (AS)21,
Consolidated Financial Statements, specifies the requirements relating to consolidated
financial statements. This statement should be applied in accounting for borrowing
costs.
In case of a parent(holding enterprise), users of financial statements are usually
concerned with, a need to be informed about, the results of operations of both the
enterprise itself as well as of the group as a whole. Accordingly, in the case of such
enterprises, this Standard requires the presentation of earnings per share information on
the basis of consolidated financial statements as well as individual financial statements
of the parent. In consolidated financial statements, such information is presented on the
basis of consolidated information.

1.4 ADVANTAGES

EPS is very easily to compute its value and comparing with the previous period in
performance.

EPS its help in measuring performance of the company by bringing the sign
indicators of company to continues with business.

EPS it considering the time factor by taking the current time in measuring
performance in relation to the extracted data.

1.5 DISADVANTAGES

EPS can be affected by changes in a companys accounting policy.

EPS yields growth percentages that can be misleading or meaningless when based
on a small base or negative earnings from a prior period.

EPS will be distorted if a company conducts a share buy-back. (When a company

repurchases its own shares it thereby reduces the number of shares in issue, which
automatically increases its EPS figure).

Although company management love to boast that they have increased EPS, its
worth remembering that earnings should increasethis is exactly what an investor
is looking for. Even placed in a savings account, an investors cash would earn more
each year due to compound interest (admittedly not much more these days).

EPS takes no account of a companys debt position and financial leverage, factors
that a discerning investor needs to be aware of.

EPS can be distorted by mergers and acquisitions. (For examples, regardless of the
actual value created, a deal will be earnings accretive if the acquirer's price-toearnings ratio is greater than the target's price-to-earnings ratio, including the
acquisition premium).

ACCOUNTING STANDARD (AS) 22

CHAPTER 2
ACCOUNTING FOR TAXES ON INCOME

1. INTRODUCTION
ACCOUNTING Standard(AS)22, Accounting for Taxes on Income, issued by the
Council of the Institute of Chartered Accountants of India, comes into effect in respect
of accounting periods commencing on or after 1-4-2001. It is mandatory in nature for:
a) All the accounting periods commencing on or after 01-04-2001 in respect of the
following:

Enterprises whose equity or debt securities are listed on a recognised stock

exchange in India and enterprises that are in the process of issuing equity or debt
securities that will be listed on a recognised stock exchange in India as
evidenced by the board of directors resolution in this regards.

All the enterprises of a group, if the parent presents consolidated financial

statements and the Accounting Standard is mandatory.

b) All the accounting periods commencing on or after 01-04-2002, in respect of

companies not covered.
c) All the accounting periods commencing on or after 01-04-2006, in respect of all
enterprises.

The Guidance note on Accounting for Taxes on Income, issued by the Institute of
Chartered Accountants of India in 1991, stands withdrawn from 1-4-2001.

1.1 DEFINITIONS
For the purpose of this statement, the following terms are used with the meanings
specified:

Accounting income (loss) is the net profit or loss for a period, as reported in the
statement of profit and loss, before deducting income tax expense or adding
income tax saving.

Taxable income (tax saving) is the aggregate of current tax and deferred tax
charged or credited to the statement of profit and loss for the period.

Current tax is the amount of income tax determined to be payable (recoverable) in

respect of the taxable income (tax loss) for a period.

Deferred tax is the tax effect of timing differences.

Timing differences are the differences between taxable income and accounting
income for a period that originate in on period and are capable of reversal in one or
more subsequent periods.

Permanent differences are the differences between taxable income and accounting
income for a period that originate in one period and do not reverse subsequently.

Taxable income is calculated in accordance with tax laws. In some circumstances,

the requirement of these laws to compute taxable income differs from the
accounting policies applied to determine accounting income. The effect of this
difference is that the taxable income and accounting income may not be the same.

Unabsorbed depreciation and carry forward of losses which can be set-off against
future taxable income are also considered as timing differences and result in
deferred tax assets, subject to consideration of prudence.

1.2 SCOPE
This standard should be applied by companies. However, a Small and Medium Sized
Company, as defined in the notification, may not disclose diluted earnings per
share(both including and excluding extraordinary items).
In consolidated financial statements, the information required by this statement
should be presented on the basis of consolidated accounting Standard (AS) 21,
Consolidated Financial Statements specifies the requirements relating to consolidated
financial statements. This statement should be applied in accounting for borrowing
costs.
In case of a parent (holding enterprise), users of financial statements are usually
concerned with, and need to be informed about, the results of operations of both the
enterprises, this standard requires the presentation of earnings per share information on
the basis of consolidated financial statements as well as individual financial statements
of the parent. In consolidated financial statements, such information is presented on the
basis of consolidated information.

1.3

DIFFERENCE BETWEEN ACCOUNTING PROFITS AND

TAXABLE INCOME
There are various reasons for the above, which change the tax base itself. These causes
are:
a) Difference in the method of computation: The Income Tax Act provides specific
method of computation of income. The instances are:
i.

Income from House Property.

ii.

Capital Gain particularly for long term assets.

iii.

Allowance for depreciation based on Block of Assets carried for tax purpose and
on book value for account purpose.

iv.

The variation in the method and the rate of depreciation for two purposes.

b) Disallowance of expenses charged to Profit and Loss Account, as per the provisions
of the tax law. The instances are:
i.

Payment, otherwise than by crossed cheque.

ii.

Payment beyond specific time.

iii.

Disallowance under S:36, 37 and 40 of the Income Tax Act.

c) Items deemed to be taxable income, but not treated as income for accounting
purpose.
d) Income exempted from tax but credited to Profit and Loss Account.
e) Deductions for tax purpose, out of profits but not considered as expenses for
accounts purpose.
f) Special tax applicable e.g. Minimum Alternate Tax.
g) Tax charged on Presumptive basis disregarding accounting profit.
h) Varying rate of tax for specific income e.g. for long term capital gains, lottery
winnings.
All these issues result in variation between Book profit and taxable income.

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VALUATION OF BUSISNESS
CHAPTER 3
1. INTRODUCTION
BUSINESS:
The etymology of business refers to the state of being busy, in the context of the
individual as well as the community or society. In other words, to be busy is to be doing
commercially viable and profitable work.
In economics, business is the social science of managing people to organize and
maintain collective productivity toward accomplishing particular creative and
productive goals, usually to generate profit.
The term business has at least three usages, depending on the scope|- the general
usage(above), the singular usage to refer to a particular company or corporations, and
the generalized usage to refer to a particular market sector, such as the record
business, the computer business, or the business community the community of
suppliers of goods and services.

VALUATION:
The dictionary meaning of Valuation is The act or process of assessing value or
price. Business valuation is the act or process of assessing value or price of financial
asset liability. Financial valuation involves valuation of assets as well as valuation of the
complete business.

BUSINESS VALUATION:
A business valuation determines the value of a business enterprise or ownership
interest. A valuation estimates the economic benefits that arises from combining a group
of physical assets with a group of intangible assets of the business as a going concern.
When valuation is done with the purpose of mergers or purchase, it estimates the price
that prospective informed buyers and sellers would negotiate at arms length for an
entire business or a partial equity interest. The methods used for the purpose usually
depend upon purpose.

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1.1 NEED FOR VALUATION

All sorts of events could trigger a need for a valuation; so whenever major changes
occur within the business discuss with check with the accountant or consultant whether
valuation will be beneficial or required. Valuation may be required for the following
purposes.
a) Disputing the conclusions of regulatory investigation.
b) Planning for an initial public offering of company shares.
c) Selling the company or hiving off a division.
d) Conducting a major strategic planning
e) Applying for loan.
f) Seeking investors.
g) Creating a company stock option plan.
h) Breaking up a partnership.
i) Getting a divorce.
j) Liquidation/filing for bankruptcy.
k) Doing estate or gift planning that involves company stock.

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2. COMPONENTS FOR VALUATION PROCESS

Valuation process includes the following stages:
a) Engagement of professional accountant/consultant
b) Research and data gathering.
c) Analysis and estimate of value.
d) Reporting process.
A) ENGAGEMENT OF PROFESSIONAL ACCOUNTANT/CONSULTANT.
Business valuation estimates of:
i.

Financial and intangible assets and liabilities such as contracts, and intellectual
property.

ii.

Businesses.

iii.

Securities such as debt, equity and derivatives.

In this last few years, professional accountants have seen dramatic changes in

accounting rules, standards, regulations and corporate governance practice. This has
been brought about sweeping changes to their traditional roles and requires them to
acquire new skills. One such area is business valuation.
Skills required from consultant/ professional accountant.
a) Understand of the concept and purpose of professional valuation within the
accounting profession.
b) Knowledge of taxation aspects-tax on sale, gains, creating tax saving entities.
c) Knowledge of Accounting standards related to business combination, intangible
assets, employee options and financial instruments.
d) Understanding of employee performance measurement criteria when valuation is
for stock options.
e) Awareness of issues impacting clients and ability to provide advice and direction
to respond to these issues.
Selection of consultant:
While selecting the consultant the organization should follow the procedures if any for
engagement of external consultant, applicable to the organization. Although, there might
be variations depending on need and purpose, the usual steps taken would be.

13

i.

Determine whether the consultant has the competence and experience to perform the
engagement.

ii.

Determine whether the consultant has a conflict of interest with the organization.
Explore the situations or relationships which might give rise to conflict of interest. A
conflict could arise if the consultant has a relationship with a member of the
governing body or related to the interested third party. Be aware of other potential
conflicts of interest that may distract, or undermine, the work to be done.

iii.

Determine if the consultant has sufficient resources to perform the work in the time
frame specified.

iv.

Consider Scope of work to be performed and other issues, including the

determination and plan for payment of fees and expenses.

v.

Determine the criteria that will be used to measure the consultant work and
document those criteria in an agreement with the consultant.

vi.

Decide on format of report and areas to be included.

vii.

Since the consultant will have access to business information, some of which will be
confidential, the agreement should include a confidentiality clause.

viii.

Determine the legal interest to be valued and purpose of valuation

B) RESEARCH AND DATA GATHERING
The consultant requires certain information to perform the engagement. Most of the data
is available within the organization.
a) The nature of the business.
b) The history of the business.
c) The economic outlook and the conditions of the specific industry.
d) The book value of the stock.
e) The financial condition and management of the company.
f) The dividend paying capacity and dividend paying history of the company.
g) Previous sales of stock.
h) Dividend paying capacity and history.
i) Market price of comparable publicity traded companies.
j) Goodwill of the company.,
k) Dependency of companys value on current management.

14

Information to be provided to the consultant includes financial and corporate documents

and other information including:
a) Financial statements.
b) Corporate documents for your company.
c) Governance body minutes.
d) Organization chart.
e) Tax returns.
f) Accounts receivable, accounts payable and inventory detail.
g) Contracts/leases.
h) Budgets/forecasts.
i) Marketing material/price list.
j) List of liabilities, loans and mortgages including taxes, insurance policies, etc.
k) Valuation of intangible assets, goodwill, trademarks, etc.
l) List of Services/ products.
m) Present Marketing and Advertising Information.
n) Major competitors and market position.
o) Customer lists.
p) Financing terms.
q) Financing for possible expansion and projections for financial statements.
r) Other inducements, present employees, managers, etc.

C) ANALYSIS AND ESTIMATE OF VALUE

The organization and the consultant have to decide on business valuation method to be
used based on the nature and requirements of the engagement. This will also involve
analysing the company information in conjunction with the industry and other
comparable company data.

15

D) DOCUMENTATION AND REPORTING

I.

WORKING PAPERS.
The normal professional principles with respect to working papers are to be applied for
business valuations too. The consultant should ensure that he receives a letter of
representation and provide an engagement letter.
The working papers must enable a knowledge third party to understand the results of
valuation and estimates effects on business valuation .

II.

VALUATION REPORT.
The contents of the report should include the FOLLOWING:
1. Description of valuation engagement
a. Name of the client.
b. Engagement.
2.

Description of business being valued

a. Legal background.
b. Financial aspects.
c. Tax matters.

3.

Description of the information underlying the valuation

a. Analysis of past results.
b. Budgets, with underlying assumptions.
c. Availability and quality of underlying data.
d. Review of budgets for plausibility
e. Statements of responsibility for information received.

4. Description of specific valuation of assets used in the business

a. Procedure
b. The principles used in the valuation.
c. Description of the procedures carried out.
d. The valuation method used.
e. The procedures involved in making projections.
f. The scope and quality of underlying data.

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III.

TYPES OF VALUATION REPORT

Typical valuation reports include:
a) Limited Scope Valuations:
Limited Scope Calculations of value reports are particularly useful for small
businesses whose owners are considering the sale of the business.
b) Formal Valuations:
A Formal Valuations report is the next step up from a Limited Scope Valuation and
involves more detailed analysis with market research to support the end result. The
final suggested value is not a range, but rather a distilled value of the business.
Formal Valuations are used for businesses which are contemplating an uncontested
sale of their shares in the business.
c) Mergers and Acquisition:
This type of report is used where shareholders or interested parties in the company
want to obtain the value of a business. It typically takes longer than Limited Scope
or Formal Valuations to complete the analysis, interviews and written report that are
involved in this type of valuation. Such reports reflects the more complex and
detailed analysis that needs to be done to arrive at the business value in this context.
d) Comprehensive Valuations:
These valuation reports are much more comprehensive and detailed than the other
types of valuation reports and because of their purpose require extensive
documentation. The valuators involved in these reports are litigation-trained and
accredited business valuators who can be made available to provide testimony and
litigation support to assist with critiquing opposing valuation testimony.

17

3. BUSINESS VALUATION METHODS:

The following are some of the business valuation methods:
I.

DISCOUNTED CASH FLOW(DCF) METHOD:

The discounted Cash Flow (DCF) methodology expresses the present value of a
business as a function of its future cash earnings capacity. This methodology works on
the premise that the value of a business is measured in terms of future cash flow
streams, discounted to the present time at an appropriate discount rate.
This method is used to determine the present value of a business on a going concern
assumptions. It recognizes that money has a time value by discounting future cash flows
at an appropriate discount factor. The DCF methodology depends on the projection of
the future cash flows and the selection of an appropriate discount factor.
The further the cash flows can be projected, the less sensitive the valuation is to
inaccuracies in the assumed terminal value. Therefore, the longer the period covered by
the projection, the less reliable the projections are likely to be. For this reason, the
approach is used to value businesses, where the future cash flows can be projected with
a reasonable degree of reliability. For example, in a fast changing market like telecom
or even automobile, the explicit period typically cannot be more than at least 5 years.
Any projection beyond that would be mostly speculations.
The discount rate applied to estimate the present value of explicit forecast period free
cash flow as also continuing value, is taken at the Weighted Average Cost of Capital.
One of the advantages of DCF approach is that it permits the various elements that make
up the discount factor to be considered separately, and thus, the effect of the variations
in the assumptions can be modelled more easily. The principal elements WACC are cost
of equity, the post-tax cost of debt and the target capital structure of the company. In
turn, cost of equity is derived, on the basis of capital asset pricing model, as a function
of risk-free rate, Beta and equity risk premium assigned to the subject equity market.

18

II.

BALANCE SHEET METHOD OR NET ASSET VALUE METHOD:

The Balance sheet or the Net Asset Value methodology values a business on the basis
of the value of its underlying assets. This is relevant where the value of the business is
fairly represented by its underlying assets. The NAV method is normally used to
determine the minimum price seller would be willing to accept and, thus serves to
establish the floor for the value of the business. This method is pertinent where: The value of intangibles is not significant.
The business has been recently set up.
This method takes into account the net value of the assets of a business or the
capital employed as represented in the financial statements. Hence, this method takes
into account the amount that is historically spent and earned from the business. This
method does not, however, consider the earnings potential of the assets and is, therefore,
seldom used for valuing a going concern. The above method is not considered
appropriate, particularly in the following cases.
When financial statement sheets do not reflect the true value of assets, being
either too high on account of possible losses not reflected in the balance sheet or
too low because of initial losses which may not continue in future.
Where intangible such as brand, goodwill, marketing infrastructure, and product
development capabilities, etc. form a major part of the value of the company.
Where due to the changes in industry, market or business environment, the assets
of the company have become redundant and their ability to create net positive
cash flow in future is limited.

III.

MARKET MULTIPLE METHOD:

This method takes into account the traded or transaction value of comparable companies
in the industry and benchmarks it against certain parameters, like earnings, sales, etc.
Two of such commonly used parameters are:
Earnings before Interest, Taxes, Depreciation and Amortizations(EBITDA)
Sales.
Although the Market Multiples Method captures most value elements of a business,
it is based on the past/current transactions or traded values and does not reflect the
possible changes in future of the trend of cash flow being generated by a business,
19

neither takes into account the time value of money adequately. At the same time it is a
reflection of the current view of the market and hence is considered as a useful rule of
thumb, providing reasonableness checks to valuations arrived at from other approaches.
Accordingly, one may have to review a series of comparable transactions to determine a
range of appropriate capitalization factors to value a company as per this methodology.
IV.

ASSET VALUATION METHOD:

This asset valuation methodology essentially the cost of replacing the tangible assets of
the business. The replacement cost takes into account the market value of various assets
or the expenditure required to create the infrastructure exactly similar to that of a
company being valued. Since the replacement methodology assumes the value of a
business as is a business is set, this methodology may not relevant in a going concern.
Instead it will be more realistic if asset valuation is done on the basis of the new book
value of the assets. The asset valuation is a good indicator of the entry barrier that exists
in a business. Alternatively, this methodology can also assume the amount which can be
realized by liquidating the business by selling off all the tangible assets of a company
and paying off the liabilities.

V.

LIQUIDATION VALUE:
Liquidation value uses the value of the assets at liquidation. Liabilities are deducted
from the liquidation value of the assets to determine the liquidation value of the
business. Liquidation value can be used to determine the bare bottom benchmark value.

VI.

CAPITALIZATION METHODS:
This method calculates a businesss value by discounting the future business profits or
dividends flowing to the entitys owners, which is derived from future commercial
profits. There are two methods:

INCOME CAPITALIZATION VALUE METHOD:

First determine the capitalization rate- a rate of return to take on the risk of
operating the business. Earnings are then divided by that capitalization rate. The
earnings figure to be capitalized should be one that reflects the true nature of the
business, such as the last three years average, current year or projected year. When
determining a capitalization rate, compare with rates available to similarity risky
investments.

20

DIVIDEND CAPITALIZATION:
Since most closely held companies do not pay dividends, when using dividend
capitalization consultants first determine dividend paying capacity of a business.
Dividend paying capacity depends on net income and on cash flow of the business.
To determine dividend paying capacity, near future capital requirements , expansion
plans, debt repayment, operation cushion, contractual requirements, past dividend
paying history of a business should be studied. After analysing these factors, per
cent of average net income and of average cash flow that can be used for the
repayment of dividends can be estimated. The dividend yield can be determined by
analysing comparable companies.

21

4. COST OF VALUATION
The factors that influence the cost of a valuation are:

The availability, completeness and organization of the companys

financial records

Revenue of the business

The purpose of the valuation

The type of details required in the report

As an example, a valuation prepared for estate planning with a limited scope report will
cost significantly less than a valuation prepared for a high net worth divorce case that
requires a full scope report and expert testimony in a court proceedings.

4.1 FEE STRUCTURE:

Usually the fees are structured in the following manner:
a) A deposit to review the project and list of fixed assets.
b) After the review, the adviser will prepare an outline for business valuation
and will prepare a quote for services.
c) Disbursements and other miscellaneous charges are additional. These
include expenses incurred during the project, for example, travelling,
telephone and photocopy.

4.2 HOW TO REDUCE THE PRICE OF VALUATION:

These are four key steps that a client can take to reduce the cost of the valuation
engagement. The two most important steps for the client are to be open and honest
with the valuator during the engagement and to keep detailed and organized
financial records. Client should also consider having valuations done on a periodic
basis. This will significantly reduce the time spent by the valuator in the research
and data gathering phase. Finally, like any other significant purchase, the client
should do comparative shopping and get at least two or three quotes for the
assignment.

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5.

BUSINESS

VALUATION

METHODS

AND

DIFFERENT

PRODUCTION RESULTS
Is it possible to use the income business valuation methods and arrive at different
results? Yes indeed! Consider two prospective business buyers doing the income
projections and assessing the risk of owning a given business.
Each buyer will likely have a different perception of the risk involved, hence their
capitalization and discount rates will differ. Also, the two buyers may have different
plans for the business, which will affect how they project the income stream.
Thus, even if they use the same valuation methods the resulting value conclusions may
be quite different. Put another way, the two buyers apply the so-called investment
value standard to determine the business worth. They measure the business value
differently, based on their unique ownership or investment objectives.
This flexibility of measuring the business worth to match ones objectives is one of the
greatest strengths of the income valuation approach.

23

6.

KEY CONCEPTS
The following are some key concepts you will need to understand when valuing a
business.

FAIR SALARY FOR OWNER:

Owners who work in their business are entitled to a fair salary for their work, just
as anyone else is. This is the concept of a fair salary for owner - the amount you'd
pay someone else to do the hands-on work you'd do. This amount includes
superannuation.
Keep in mind that fair salary is what you'd be willing to pay someone else to do
your job. It doesn't include additional amounts or an inflated salary you might be
willing to pay yourself.
For example, imagine you're considering buying a business for $100,000 and
the annual net profit is $70,000. You discover that this figure hasn't yet had a fair
salary for owner deducted which, given the hours you'd need to work on the
business, is $65,000. The net profit after deducting fair salary for owner is $5,000 the return you could expect if you put your $100,000 in a bank.

FAIR RETURN ON INVESTMENT(ROI):

If you have a sum of money to invest, you'll expect a return on it. If you put it in a
bank, you'd get a certain return on that investment (ROI). If, instead of putting
your money in a bank, you invested it in a business, the return you'd expect to
make would be greater because the associated risks and level of effort required are
higher.
Fair ROI refers to the return you expect to receive in the current marketplace for a
riskier investment than putting funds in a bank.
The fair ROI you'd expect would be in direct proportion to the risks involved. For
example, if you invested in a very speculative business venture with a high degree
of risk, you'd expect a very high rate of return if it did prove successful.

FAIR RETURN ON NET TANGIBLE ASSETS:

A specific example of fair ROI is fair return on net tangible assets. This is the
return you'd expect from the net tangible assets of a business.
24

For example, a business has tangible assets of $200,000, liabilities of $80,000

and intangible assets (including goodwill) totalling $20,000. The net tangible
assets of this business are $200,000 minus $80,000, or $120,000. Net tangible
assets include only tangible asset minus liabilities.
The fair return on net tangible assets you'd expect to get from this business,
assuming you have an expected ROI of 20%, would be 20% of $120,000 or
$24,000.

SUPER PROFIT:
Super profit is the excess a business might return you after you've taken out fair
salary for owner and fair return on net tangible assets. It's the amount you'd expect
to receive from the business after deducting what you'd receive if you got a job in
the business and invested the money you'd spend on the net tangible assets
elsewhere.

25

CHAPTER 4
COMPANY PROFILE
Quest Profin Advisor Private Limited(Quest) is a Mumbai based Financial Advisors
established in 1994. Quest is promoted by professionals having an experience of more
than two decades in the field of Corporate Finance and Advisory. Quest has a dedicated
team of experience. Professionals specialized in a wide range of Financial Services and
corporate Laws.
Quest is the Financial Consultancy arm of a 20-year-old firm of Chartered accountants.
They are engaged in providing Corporate Advisory services to reputed Companies in
Financial Structuring. Project Funding, Private Equity, Loan Syndication, IPO
Management, Compliance, Due Diligence and Corporate Law matters. Over the years,
they have provided their services to a number of corporate clients including MNCs, NRI
as well as Indian companies. They are a team of MBAs/ Chartered Accountants, have
handled various types of assignments involving funds raising and corporate advisory
and earned reputation for their knowledge of corporate laws, diligence and task-oriented
approach and adaptation to the latest trends in the industry.

26

4.1 VALUATION AT QUEST

The firm being a boutique investment firm had many cases dealing with the valuation of
companies. Maximum cases were of clients having unlisted firms, which made the task
although more difficult. The four main methods that were widely followed at the firm
were:
1. Discounted Cash Flow (DCF)
2. Profit Earning Capacity Value(PECV)
3. Net Asset Value(NAV)
4. Peer Comparison (Mcap/Sales multiple)

We will see the calculation of value of the firm via the above methods with an
example. Shown below are the income statement and balance sheet of XYZ Ltd firm.
The data for 2010-11 is given. While projections are being made for the next five
years. The valuation of the firm is being made on going concern basis.
The companys cost of capital is 15% and it is growing at 3%.

27

INCOME STATEMENT
SALES

(Rs Lakhs)
2012-13

2013-14

2014-15

2015-16

5813.25

7145.7

8487.51

9877.56

9999.85

7.67

8.67

8.77

8.92

9.25

9.88

Misc. Income

Total growth

5729.89

5899.51

6002.41

6700.58

8500.54

9751.84

COGS

4927.46

4001.90

5769.85

5899.49

6148.79

7459.25

Direct

158.84

208.68

255.59

289.13

315.75

389.45

5086.30

5555.53

5987.65

6217.23

7896.64

8467.26

Gross Profit

643.60

700.46

745.65

789.65

809.78

845.23

Margin

11.23%

20.09%

21.86%

28.98%

28.97%

29.87%

209.61

357.89

399.45

412.87

487.65

512.45

Total

209.61

512.58

555.89

615.89

687.89

690.87

EBITDA

433.98

513.52

587.65

412.79

587.65

642.13

Margin

107.37

158.94

168.79

245.79

278.36

301.28

EBIT

433.98

588.65

612.13

678.93

725.31

876.32

Margin

212.76

232.79

245.87

287.65

345.78

387.65

PAT

27.61

29.87

29.99

30.15

30.56

31.12

Margin

0.48%

2.82%

8.55%

9.44%

9.56%

10.38%

2010-

2011-

11

12

Domestic

5722.23

Exports

y-o-y

expenses
Total cost of
production

Admin

and

other
expenses

depreciation

Interest

28

CASHFLOW

(Rs Lakhs)
2011-12

2012-13

2013-

2014-

14

15

2015-16

NPAT

167.87

1158.83

1178.87

1247.98

1832.85

Add:

7.37

8.14

8.45

8.99

9.24

Add: Interest

143.40

135.93

128.66

121.40

114.65

Operating

318.44

1302.92

1315.98

1378.37

1956.74

504.94

2479.62

289.63

429.63

321.50

800.00

1340.94

2479.62

289.62

429.50

321.50

(862.31)

(1018.18)

1369.34

1396.28

1698.63

(749.68)

(769.82)

900.30

782.89

844.47

Depreciation

cash flow
Investment in
WC
Investment in
Gross

Fixed

Assets
Net
Investment
Free

Cash

Flow
Discounted
Cash Flow
14579.04

Value at end
of

explicit

period
7248.36

Present
Value of the
above
Present

8256.37

Enterprise
29

Value
1615.28

Less:
illiquidity
discount(20%)

6605.10

Net
Valuation
Discount Rate

15%

Growth

3%

after

rate

explicit

period

Calculation of Net Asset Values Based on Intrinsic Value

Particulars

Intrinsic
Value

Market value of Fixed Assets( including land)

3606.64

Market Assets of Current Assets Loan and Advances

3062.17

Total

6668.81

Less- Liabilities
Secured Loan

1830.48

Unsecured Loan

Current Liabilities and Provisions

1267.72

Net Intrinsic Value

3571.11

30

Calculation of PECV based on Projected Profits

Particulars

Amount

Projected Profits After Tax for Fiscal 2010-11 (in lakhs)

167.87

Projected Profits After Tax for Fiscal 2011-12 (in lakhs)

1158.23

Projected Profits After Tax for Fiscal 2012-13 (in lakhs)

1362.56

Average Profit

896.22

Expected rate of Return (for Investor)

13.2%

Fair Value of the Firm

6787.87

Expected Return is calculated after tax = 20*(1.33)

= 13.2%
Peer comparison using Mcap/ Sales Multiple
An analysis of similar companies to XYZ was done and Ratio Market Cap/ sales of all
companies was found.
MCap/ Salesavg= 0.40
Considering this average multiple for XYZ, we calculate sales for XYZ
= 0.40*5729.89
=2290 lac
Based on this Market Cap of the XYZ company is found to be 2290 lac.
As seen from above methods the value of the firm ranges widely depend on the purpose
and method used. The firm would then be valued as per the need of the buyer or the
investor and approach suitable to him.

31

7. CONCLUSION
To conclude, a valuation provides the foundation for skilled business appraisers to
estimate what your business is worth. Valuation is frequently used in setting a price for
an enterprise that is being bought or sold. Professional valuations are now also being
used by financial institutions to determine the amount of credit that should be extended
to a company, by courts in determining litigation settlement amounts and by investors in
evaluating performance of company management. Lastly, a valuation is often required
under a variety of accounting and tax regulations.
Hence there are many important reasons that business owners should know the value
of their business long before they decide to sell.

32

8. BIBLIOGRAPHY

Alfred Rappaport and Michael Mauboussin (Columbia Business School): How Do You
Assess The Value of A Company's "Real Options"?

Anderson, Patrick L., "Value of Private Businesses in the United States," Business
Economics (2009) 44, 87108.

Aswath Damodaran (Stern School of Business):Applications Of Option Pricing Theory

To Equity Valuation and Option Pricing Applications in Valuation.

Black, Fischer; Myron Scholes (1973). "The Pricing of Options and Corporate
Liabilities". Journal of Political Economy.

Brennan, J.; Schwartz, E. (1985). "Evaluating Natural Resource Investments". The

Journal of Business.

33