2 Purpose of Valuation and Premises of Valuation

INTRODUCTION

In this global around us, where we are living this term “Valuation” has wider importance. What is actually this term “Value”, how it differs from the term “Price”. Both of these words have its own significance and meaning. Price denotes the money that you pay for acquiring something or you are willing to pay whereas the term Value has more relevance. Value denotes the monetary worth of particular things or asset or liability etc which reflect the importance or necessity of something to you. “Value” is what you believe the product or a service is worth to you.

PURPOSE & OBJECTIVE OF VALUATION

A valuation is undertaken for one or more of several reasons/objective i.e. for valuation of any business, for acquiring any business, merger and acquisition, for liquidation, start-up valuation, distress firm valuation, intangible valuation etc and many more.

Valuation require a detailed understanding of various factors affecting value, professional judgment and exercise. Need for valuation depend upon various circumstances and situation prevailing in the market and the necessity and objectives of the person approaching for valuation.
Some of the common purposes of valuation are as follows:

Transaction based

  • Merger and acquisition
  • Demerger
  • Leverage buy out
  • Management buy out
  • Restructuring
  • Recapitalization
  • Buy back of shares
  • Project financing
  • Litigation and court case
  • Bankruptcy and Insolvency
  • Contractual disputes
  • Ownership disputes
  • Divorce cases

Compliance purpose

  • Fair Value
  • Tax issue
  • Financial reporting
  • Planning purpose
  • Personal finance planning
  • Strategic planning
  • M&A planning

Purpose of Valuation and Premises of Valuation

PREMISES OF VALUATION

This is the basic and the foremost step to be undertaken before commencing any valuation assignment. We need to first understand the motive/objective of the client and the circumstance and conditions affecting the subject asset/liability under valuation. Whether we are going to value the asset or liability or business that is going to run for long or we are valuing for any distressed business that is going to shut down. Depending upon the premises of valuation that we have selected, we will consider all the circumstances and conditions that are relevant for the intended purpose.

  • GOING CONCERN

Under this approach, it is assumed that the particular business is a going concern. Going concern “an ongoing operating business enterprise”. While carrying out any valuation assignment we generally take going concern as premises of value. Under this approach we make an assessment considering the potential of the business to grow and survive in this competitive environment by analyzing its strength and opportunities and to identify and overcome its threats and weakness. There are various model and school of thought for assessing the growth and shortcoming of the business like SWOT Model, Michael Porter Five forces, Pest Analysis etc. Under this going concern premise of valuation, we carry out valuation assignment considering all the factors mentioned below:

Highest and Best Use-(HABU Model)

In accordance with IND AS 113, it takes into account a market participant’s ability to generate economic benefits by using the asset in its highest or best use or by selling it to another person that would use the asset in its highest and best use. The highest and best use must be physically possible, financially feasible and legally allowed. For example- A vendor running bakery business generating heavy revenue from its bakery products has now decided to lent its trademark/ or give its franchise to other person so that to make the best and highest use of its asset.

The highest and best use of asset provides maximum value to market participant through its use in combination with other asset as a group or in combination with other asset or liability.

Current or existing use

Current or existing use is the current way an asset, liability, or a group of asset, or liability or a group of liability is used. The current use may be, but is not necessarily, also the highest and best use.

  • LIQUIDATION PREMISE OF VALUATION

Under this premise of valuation, we carry out valuation assignment assuming the business is going to wind up or carrying out the valuation of distressed business. Depending upon the circumstance and condition adversely affecting the business, Liquidation can be either orderly or forced

Orderly liquidation- Under this, asset or liability is sold under normal market condition where the seller has reasonable time and devoted its effort for its marketability and gets the reasonable price of the subject asset or liability.

Forced Liquidation- Under this, the seller is under compulsion and forced to sell the particular asset or liability without its marketability , a proper marketing period is not possible and the buyer may not be able to undertake due diligence.

TYPES OF VALUE

Intrinsic Value- Intrinsic value is a measure of what an asset is worth. This measure is arrived at by means of an objective calculation or complex financial model. Intrinsic value is different from the current market price of an asset. However, comparing it to that current price can give investors an idea of whether the asset is undervalued or overvalued.

For the purpose of carrying out valuation, there are various valuation approaches and methods used for determining the intrinsic value of the subject asset or liability. There is no universal standard for calculating the intrinsic value of a company or stock. Financial analysts attempt to determine an asset’s intrinsic value by using fundamental and technical analyses to gauge its actual financial performance. There are discounted cash flows method, relative valuation methods, replacement cost method, reproduction cost method, relief from royalty methods used by the valuer to determine the intrinsic or underlying value of the asset or liability. For eg.- In options pricing, intrinsic value is the difference between the strike price of the option and the current market price of the underlying asset.

  • Participant Specific Value

Participant specific value denote the value of the subject asset or liability considering the specific advantage of the asset or liability from the point of view of the acquirer which is not available to other person or any other acquirer in general. For example, Facebook acquire whatsapp at a price which is more than its net worth and inspite of its accumulated losses, here Facebook pay more attention to the No of users associated or using the whatsapp which in future can become prospective users of Facebook and which may be overlooked or may not be valuable for any other acquirer. Participant Specific value captures the set of characteristic that makes the business or its asset valuable to the specific investor.

Participant specific value is the estimated value of an asset or liability considering specific advantages or disadvantages of either of the owner or identified acquirer or identified participants.

  • Synergistic Value

This is the value which arises from the combination of two or more asset or businesses that has a higher value than the sum of the individual one. Synergy is a term that is most commonly used in the context of mergers and acquisitions (M&A). Synergy, or the potential financial benefit achieved through the combining of companies, is often a driving force behind a merger. If two companies can merge to create greater efficiency or scale, the result is what is sometimes referred to as a synergy merge. The expected synergy achieved through a merger can be attributed to various factors, such as increased revenues, combined talent and technology, and cost reduction. In addition to merging with another company, a company can also create synergy by combining products or markets, such as when one company cross-sells another company’s products to increase revenues.

Companies can also achieve synergy between different departments by setting up cross-disciplinary workgroups in which teams work cooperatively to increase productivity and innovation. For example, a retail business that sells clothes may decide to cross-sell products by offering accessories, such as jewelry or belts, to increase revenue.

  • Fair Value

Fair value is a market-based measurement, not an entity-specific measurement. Because fair value is a market-based measurement, it is measured using the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. It is the price at which an orderly transaction to sell the asset or transfer the liability would take place between market participant at the measurement date under current market condition. Fair value is the estimated price at which an asset is bought or sold when both the buyer and seller freely agree on a price. An entity measure Fair value using valuation technique that maximize the use of relevant observable input and minimize the use of unobservable input.

Observable input like if the shares of the particular company are listed then its quoted price/traded price in an active market become its observable input to determine fair value of shares. However if the company is a closely held company whose shares are not listed , then valuation technique will be used that takes into the future cash flows the that a market participant would expect to receive from holding the particular asset or liability. Fair value accounting is the practice of measuring a business’s liabilities and assets at their current market value. If the fair value of a stock share is $100, and the market price is $95, an investor may consider the stock undervalued and buy the stock. If the market price is $120, the investor will likely forego the purchase as the market value does not align with their idea of fair value.

Author Bio

Qualification: CA in Practice
Company: GEETANJALI PANDEY & CO
Location: LUCKNOW, Uttar Pradesh, IN
Member Since: 26 Apr 2020 | Total Posts: 12
PRACTICING CHARTERED ACCOUNTANT SINCE NOV 2018 reach me at geet.2505@gmail.com or contact - 9565640700 View Full Profile

My Published Posts

Join Taxguru’s Network for Latest updates on Income Tax, GST, Company Law, Corporate Laws and other related subjects.

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Whatsapp

taxguru on whatsapp GROUP LINK

Join us on Telegram

taxguru on telegram GROUP LINK

Review us on Google

More Under Finance

Leave a Comment

Your email address will not be published. Required fields are marked *

Search Posts by Date

February 2023
M T W T F S S
 12345
6789101112
13141516171819
20212223242526
2728