VALUATION CONCEPTS AND

METHODS
INSTRUCTIONAL MATERIALS

HERBERT C. BARON
ANDREW TIMOTHY L. CACHERO
MARVIN V. LASCANO
LUZVIMINDA S. PAYONGAYONG
MARIA LUISA U. OLIVEROS
 Module 1 – Introduction on Valuation Concepts
and Methods

Overview:

There is no doubt that the “value” is the defining measurement of any market in the
economy of today. Value is all about how much something is worth, whether in an estimate
or exact amount. When somebody invest, they expect the “value” of their investment to
increase by an amout that is acceptable to them or sufficient enough to compensate the risk
or sacrifice they took, incorporating the time value of money. As we say, in everything we
do, we need to sacrifice. That sacrifice has value, giving away something that is valuable to
him expecting another value, the return or profits he is willing to accept given the value of
his sacrifice.

Therefore, knowing how to measure value or how to create value is an essential tool for
everybody to be able to make a decision, wise decisions.

Module Objectives:
After successful completion of this module, you should be able to:

 Discuss the importance of valuation in accountancy profession

 Discuss why people needs to apply valuation techniques
 Identify the appropriate valuation techniques

Course Materials:
• Foundations of value

There is no doubt that the “value” is the defining measurement of any market
in the economy of today. Value is all about how much something is worth, whether in
an estimate or exact amount. When somebody invest, they expect the “value” of their
investment to increase by an amout that is acceptable to them or sufficient enough
to compensate the risk or sacrifice they took, incorporating the time value of money.
As we say, in everything we do, we need to sacrifice. That sacrifice has value, giving
away something that is valuable to him expecting another value, the return or profits
he is willing to accept given the value of his sacrifice.

Therefore, knowing how to measure value or how to create value is an

essential tool for everybody to be able to make a decision, wise decisions.

• Definition of valuation
 Valuation is the analytical (quantitative) process of determing the current or
projected worth (value) of an asset or something. There are several techniques or
methods available to be used in doing valuation. Each of these methods may give
different results or value, what matter is how this will be used in the decisions why
such valuation activity is being done.

Valuation determines the economic value of a business, asset or company.

• Frameworks for valuation

Conceptual frameworks of valuation is about the issue of what affects or what

drives the value to change. A company’s value is driven by its ability to earn a good
or healthy return on invested capital (ROIC) and by its ability to grow. Healthy rates
of return and growth result in high cash flows, the ultimate source of value.
Discussions on this will be done in detail in the topic, step by step process of
valuation.

• Concepts of valuation

Valuation is based on economic factors, industry variables, and on the

analysis of financial statements and the entire outlook of the firm. Valuation process
will determine the long-run fundamental economic value of its common stock or
preferred stock. Different concepts of valuation are based on the following:
1. Going concern value
2. Liquidation value
3. Market value
4. Book value
5. Intrinsic value

Details of the above concepts will be discussed in the respective topics.

When dealing with the valuation process, it is important to get as many

facts as possible with clear goals on what is the purpose of this valuation.
1. Why are you valuing?
2. What are you trying to accomplish with this valuation?

• Objectives/uses of valuation

Valuation is useful when we are trying to determine the fair value of an asset.
Fair value is the amount which is determined by what is the buyer willing to pay and
the seller is willing to sell under the conditions that both parties are willing or voluntarily
enter in the exchage transaction.

• Importance/Rationale of valuation
 Business valuation is an important exercise since it can help in improving the
company. Here are some of the reasons why is there a need to perform a business
valuation.

Although the goal of valuation is to determine the fair market value, there is
no one way to be certain of the ultimate price paid. Typically, it depends on many
factors including industry, sector, valuation method and the economic conditions.
You can also count on a fact, you can have your business valued by two
professionals and you will come up with two different answers

Various reasons for performing a business valuation

 Litigation

In a court case, such as an injury case, divorce, or where there is an

issue with the value of the business, someone may need to provide proof of
company’s worth that could be the basis of claims for any damages, or be based
on the actual worth of your businesses and not inflated figures estimated by a
lawyer.

 Exit strategy planning

In cases where there is a plan to sell a business, it is wise to come up

with a base value for the company and then come up with a strategy to enhance
the company’s profitability so as to increase its value as an exit strategy. Your
business exit strategy needs to start early enough before the exit, addressing both
involuntary and voluntary transfers.

A valuation with annual updates will keep the business ready for
unexpected and expected sale. It will also ensure that you have correct
information on the company fair market value and prevent capital loss due to
lack of clarity or inaccuracies.

 Buying a business

Sellers and buyers of business usually have different opinions on the

worth of the business. However, the real business value is what the buyers are
willing to pay. A sound business valuation should consider market conditions,
potential income, and other similar concerns to ensure that the investment being
done is viable. Business buyers must exercise prudence by normally hiring a
business broker who can help you with the process.

 Selling a business

As mentioned, sellers and buyers usually have different opinions on the

worth of the business. The sellers, however, would want to be certain that they
are getting what it is worth, thus they may have to perform their valuation process
as well.
  Strategic planning

The true value of assets may not necessarily be reflected on the assets
schedule, and if there has been no adjustment of the balance sheet for various
possible changes, it may be risky. Having a current valuation of the business will
give you good information that will help you make better business decisions. As
in the financial reporting standards, the use of current value accounting is more
evident.

 Funding

Bankers, financing companies or any potential investors require an

objective valuation when someone is negotiating or applying for credits, loans or
any funding requirements. Professional documentation of your company’s worth
is usually required since it enhances your credibility to the lenders or potential
investors.

 Selling a share in a business

For business owners, proper business valuation enables you to know the
worth of your shares and be ready when you want to sell them. Just like during
the sale of the business, you ought to ensure you get good value from your share.

Business valuation is a critical financial analysis that needs to be done by

a valuation expert who has appropriate qualifications. Business owners are able
to negotiate a tactical sale of their entity, plan an exit strategy, acquire financing,
and reduce the financial risk during litigation.

• Fundamental principles of valuation or value creation

Business valuation involves the determination of the fair economic value of

a company or business for various reasons as mentioned earlier.

Key Principles of Business Valuation

The following are the key principles of business valuation that business
owners who want to create value in their business must know.

 The value of a business is defined only at a specific point in time.

The value of a business usually experiences changes every single day.

The earnings, cash position, working capital, and market conditions of a business
are always changing. The valuation made by business owners a months or years
ago may not reflect the true current value of the business. The value of a
business requires consistent and regular monitoring. This
 valuation principle helps business owners to understand the significance of the
date of valuation in the process of business valuation.

 Value primarily varies in accordance with the capacity of a business to

generate future cash flow

A company’s valuation is essentially a function of its future cash flows

except in in unusual situations where net asset liquidation may lead to a higher
value.

The consideration here is the term “future.” It implies that historical results
of the company’s earnings before the date of valuation are useful in predicting
the future results of the business under certain conditions. Another consideration
is the term “cash flow.” It is because cash flow, which takes into account capital
investments, working capital changes, and taxes, is the true determinant of
business value. Business owners should aim at building a comprehensive
estimate of future cash flows for their companies. Even though making estimates
is a subjective undertaking, it is vital that the value of the business is validated.
Reliable historical information will help in supporting the assumptions that the
forecasts will use.

 The market commands what the proper rate of return for investors

Market forces are usually in a state of flux, and they guide the rate of
return that is needed by potential buyers in a particular marketplace. Market
forces include the type of industry, financial costs, and the general economic
conditions. Market rates of return offer significant benchmark indicators at a
specific point in time. They influence the rates of return wanted by investors over
the long term. Business owners need to be wary or concerned of the market
forces in order to know the right time to exit that will maximize value.

 The value of a business may be impacted by underlying net tangible assets

Business valuation measures of the relationship between the

operational value of a company and its net tangible value. Theoretically, a
company with a higher underlying net tangible asset value has higher going
concern value. It is because of the availability of more security to finance the
acquisition and lower risk of investment since there are more assets to be
liquidated in case of bankruptcy. Business owners need to build an asset base.
For industries that are not capital intensive, the owners need to find means to
support the valuation of their goodwill.

 Value is influenced by transferability of future cash flows

How transferable the cash flows of the business are to a potential

acquirer will impact the value of the company. Valuable businesses usually
operate without the control of the owner. If the business owner exerts a huge
control over the delivery of service, revenue growth, maintenance of customer
 relationships, etc., then the owner will secure the goodwill and not the business.
Such a kind of personal goodwill provides very little or no commercial value and
is not transferable.

In such a case, the total value of the business to an acquirer may be

limited to the value of the company’s tangible assets in case the business owner
does not want to stay. Business owners need to build a strong management team
so that the business is capable of running efficiently even if they left the
company for a long period of time. They can build a stronger and better
management team through enhanced corporate alignment, training, and even
through hiring.

 Value is impacted by liquidity

This principle functions based on the theory of demand and supply. If the
marketplace has many potential buyers, but there are a few quality acquisition
targets, there will be a rise in valuation multiples and vice versa. In both open
market and notional valuation contexts, more business interest liquidity translates
into more business interest value. Business owners need to get the best
potential purchasers to the negotiating table to maximize price. It can be
achieved through a controlled auction process.

Although they are technical valuation concepts, the basics of the

valuation principles need to understood by business owners to help them increase
the valuation of their businesses.

Read:

Books, published materials and references on Corporate Valuation, Valuation Concepts,

Tools for Valuation

Activities/Assessments:
1. Essay. Answer the following questions using what you’ve learned in this module.
Use diagrams, if needed:
a. Why we need to value value?
b. Why valuation matters to business people?
c. Why do people perform valuations?
d. How and when to apply valuation principles?